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Price-Parity Clauses: The Good, The Bad, and the…Anticompetitive?

Andrew Mercado —  21 October 2022

[The following is a guest post from Andrew Mercado, a research assistant at the Mercatus Center at George Mason University and an adjunct professor and research assistant at George Mason’s Antonin Scalia Law School.]

Price-parity clauses have, until recently, been little discussed in the academic vertical-price-restraints literature. Their growing importance, however, cannot be ignored, and common misconceptions around their use and implementation need to be addressed. While similar in nature to both resale price maintenance and most-favored-nations clauses, the special vertical relationship between sellers and the platform inherent in price-parity clauses leads to distinct economic outcomes. Additionally, with a growing number of lawsuits targeting their use in online platform economies, it is critical to fully understand the economic incentives and outcomes stemming from price-parity clauses. 

Vertical price restraints—of which resale price maintenance (RPM) and most favored nation clauses (MFN) are among many—are both common in business and widely discussed in the academic literature. While there remains a healthy debate among academics as to the true competitive effects of these contractual arrangements, the state of U.S. jurisprudence is clear. Since the Supreme Court’s Leegin and State Oil decisions, the use of RPM is not presumed anticompetitive. Their procompetitive and anticompetitive effects must instead be assessed under a “rule of reason” framework in order to determine their legality under antitrust law. The competitive effects of MFN are also generally analyzed under the rule of reason.

Distinct from these two types of clauses, however, are price-parity clauses (PPCs). A PPC is an agreement between a platform and an independent seller under which the seller agrees to offer their goods on the platform for their lowest advertised price. While sometimes termed “platform MFNs,” the economic effects of PPCs on modern online-commerce platforms are distinct.

This commentary seeks to fill a hole in the PPC literature left by its current focus on producers that sell exclusively nonfungible products on various platforms. That literature generally finds that a PPC reduces price competition between platforms. This finding, however, is not universal. Notably absent from the discussion is any concept of multiple sellers of the same good on the same platform. Correctly accounting for this oversight leads to the conclusion that PPCs generally are both efficient and procompetitive.

Introduction

In a pair of lawsuits filed in California and the District of Columbia, Amazon has come under fire for its restrictions around pricing. These suits allege that Amazon’s restrictive PPCs harm consumers, arguing that sellers are penalized when the price for their good on Amazon is higher than on alternative platforms. They go on to claim that these provisions harm sellers, prevent platform competition, and ultimately force consumers to pay higher prices. The true competitive result of these provisions, however, is unclear.

That literature that does exist on the effects these provisions have on the competitive outcomes of platforms in online marketplaces falls fundamentally short. Jonathan Baker and Fiona Scott Morton (among others) fail to differentiate between PPCs and MFN clauses. This distinction is important because, while the impacts on consumers may be similar, the mechanisms by which the interaction occurs is not. An MFN provision stipulates that a supplier—when working with several distributors—must offer its goods to one particular distributor at terms that are better or equal to those offered to all other distributors.

PPCs, on the other hand, are agreements between sellers and platforms to ensure that the platform’s buyers have access to goods at better or equal terms as those offered the same buyers on other platforms. Sellers that are bound by a PPC and that intend to sell on multiple platforms will have to price uniformly across all platforms to satisfy the PPC. PPCs are contracts between sellers and platforms to define conduct between sellers and buyers. They do not determine conduct between sellers and the platform.

A common characteristic of MFN and PPC arrangements is that consumers are often unaware of the existence of either clause. What is not common, however, is the outcomes that stem from their use. An MFN clause only dictates the terms under which a good is sold to a distributor and does not constrain the interaction between distributors and consumers. While the lower prices realized by a distributor may be passed on as lower prices for the consumer, this is not universally true. A PPC clause, on the other hand, constrains the interactions between sellers and consumers, necessitating that the seller’s price on any given platform, by definition, must be as low as the price on all other platforms. This leads to the lowest prices for a given good in a market.

Intra-Platform Competition

The fundamental oversight in the literature is any discussion of intra-platform competition in the market for fungible goods, within which multiple sellers sell the same good on multiple platforms. Up to this point, all the discussion surrounding PPCs has centered on the Booking.com case in the European Union.

In Booking.com, the primary platform, Booking.com, instituted price-parity clauses with sellers of hotel rooms on its platform, mandating that they sell rooms on Booking.com for equal to or less than the price on all other platforms. This pricing restriction extended to the hotel’s first-party website as well.

In this case, it was alleged that consumers were worse off because the PPC unambiguously increased prices for hotel rooms. This is because, even if the hotel was willing to offer a lower price on its own website, it was unable to do so due to the PPC. This potential lower price would come about due to the low (possibly zero cost) commission a hotel must pay to sell on its own website. On the hotel’s own website, the room could be discounted by as much as the size of the commission that Booking.com took as a percentage of each sale. Further, if a competing platform chose to charge a lower commission than Booking.com, the discount could be the difference in commission rates.

While one other case, E-book MFN, is tangentially relevant, Booking.com is the only case where independent third-party sellers list a good or service for sale on a platform that imposes a PPC. While there is some evidence of harm in the market for the online booking of hotel rooms, however, hotel-room bookings are not analogous to platform-based sales of fungible goods. Sellers of hotel rooms are unable to compete to sell the same room; they can sell similarly situated, easily substitutable rooms, but the rooms are still non-fungible.

In online commerce, however, sellers regularly sell fungible goods. From lip balm and batteries to jeans and air filters, a seller of goods on an e-commerce site is among many similarly situated sellers selling nearly (or perfectly) identical products. These sellers not only have to compete with goods that are close substitutes to the good they are selling, but also with other sellers that offer an identical product.

Therefore, the conclusions found by critics of Booking.com’s PPC do not hold when removing the non-fungibility assumption. While there is some evidence that PPCs may reduce competition among platforms on the margin, there is no evidence that competition among sellers on a given platform is reduced. In fact, the PPC may increase competition by forcing all sellers on a platform to play by the same pricing rules.

We will delve into the competitive environment under a strict PPC—whereby sellers are banned from the platform when found to be in violation of the clause—and introduce the novel (and more realistic) implicit PPC, whereby sellers have incentive to comply with the PPC, but are not punished for deviation. First, however, we must understand the incentives of a seller not bound by a PPC.

Competition by sellers not bound by price-parity clauses

An individual seller in this market chooses to sell identical products at different prices across different platforms, given that the platforms may choose various levels of commission per sale. To sell the highest number of units possible, there is an incentive for sellers to steer customers to platforms that charge the lowest commission, and thereby offer the seller the most revenue possible.

Since the platforms understand the incentive to steer consumers toward low-commission platforms to increase the seller’s revenue, they may not allocate resources toward additional perks, such as free shipping. Platforms may instead compete vigorously to reduce costs in order offer the lowest commissions possible. In the long run, this race to the bottom might leave the market with one dominant and ultra-efficient naturally monopolistic platform that offers the lowest possible commission.

While this sounds excellent for consumers, since they get the lowest possible prices on all goods, this simple scenario does not incorporate non-price factors into the equation. Free shipping, handling, and physical processing; payment processing; and the time spent waiting for the good to arrive are all additional considerations that consumers factor into the equation. For a higher commission, often on the seller side, platforms may offer a number of these perks that increase consumer welfare by a greater amount than the price increase often associated with higher commissions.

In this scenario, because of the under-allocation of resources to platform efficiency, a unified logistics market may not emerge, where buyers are able to search and purchase a good; sellers are able to sell the good; and the platform is able to facilitate the shipping, processing, and handling. By fragmenting these markets—due to the inefficient allocation of capital—consumer welfare is not maximized. And while the raw price of a good is minimized, the total price of the transaction is not.

Competition by sellers bound by strict price-parity clauses

In this scenario, each platform will have some version of a PPC. When the strict PPC is enforced, a seller is restricted from selling on that platform when they are found to have broken parity. Sellers choose the platforms on which they want to sell based on which platform may generate the greatest return; they then set a single price for all platforms. The seller might then make higher returns on platforms with lower commissions and lower returns on platforms with higher commissions. Fundamentally, to sell on a platform, the seller must at least cover its marginal cost.

Due to the potential of being banned for breaking parity, sellers may have an incentive to price so low that, on some platforms, they do not turn a profit (due to high commissions) while compensating for those losses with profits earned on other platforms with lower commissions. Alternatively, sellers may choose to forgo sales on a given platform altogether if the marginal cost associated with selling on the platform under parity is too great.

For a seller to continue to sell on a platform, or to decide to sell on an additional platform, the marginal revenue associated with selling on that platform must outweigh the marginal cost. In effect, even if the commission is so high that the seller merely breaks even, it is still in the seller’s best interest to continue on the platform; only if the seller is losing money by selling on the platform is it economically rational to exit.

Within the boundaries of the platform, sellers bound by a PPC have a strong incentive to vigorously compete. Additionally, they have an incentive to compete vigorously across platforms to generate the highest possible revenue and offset any losses from high-commission platforms.

Platforms have an incentive to vigorously compete to attract buyers and sellers by offering various incentives and additional services to increase the quality of a sale. Examples of such “add-ons” include fulfilment and processing undertaken by the platform, expedited shipping and insured shipping, and authentication services and warranties.

Platforms also have an incentive to find the correct level of commission based on the add-on services that they provide. A platform that wants to offer the lowest possible prices might provide no or few add-ons and charge a low commission. Alternatively, the platform that wants to provide the highest possible quality may charge a high commission in exchange for many add-ons.

As the value that platforms can offer buyers and sellers increases, and as sellers lower their prices to maintain or increase sales, the quality bestowed upon consumers is likely to rise. Competition within the platform, however, may decline. Highly efficient sellers (those with the lowest marginal cost) may use strict PPCs—under which sellers are removed from the platform for breaking parity—to price less-efficient sellers out of the market. Additionally, efficient platforms may be able to price less-efficient platforms out of the market by offering better add-ons, starving the platforms of buyers and sellers in the long run.

Even with the existence of marginally higher prices and lower competition in the marketplace compared to a world without price parity, the marginal benefit for the consumer is likely higher. This is because the add-on services used by platforms to entice buyers and sellers to transact on a given platform, over time, cost less to provide than the benefit they bestow. Regardless of whether every single consumer realizes the full value of such added benefits, the likely result is a level of consumer welfare that is greater under price parity than in its absence.

Implicit price parity: The case of Amazon

Amazon’s price-parity-policy conditions access to some seller perks on the adherence to parity, guiding sellers toward a unified pricing scheme.  The term best suited for this type of policy is an “implicit price parity clause” (IPPC). Under this system, the incentive structure rewards sellers for pricing competitively on Amazon, without punishing alternative pricing measures. For example, if a seller sets prices higher on Amazon because it charges higher commissions than other platforms, that seller will not eligible for Amazon’s Buy Box. But they are still able to sell, market, and promote their own product on the platform. They still show up in the “other sellers” dropdown section of the product page, and consumers can choose that seller with little more than a scroll and an additional click.

While the remainder of this analysis focuses on the specific policies found on Amazon’s platform, IPPCs are found on other platforms, as well. Walmart’s marketplace contains a similar parity policy along with a similarly functioning “buy” box. eBay, too, offers a “best price guarantee,” through which the site offers match the price plus 10% of a qualified competitor within 48 hours. While this policy is not identical in nature, it is in result: prices that are identical for identical goods across multiple platforms.

Amazon’s policy may sound as if it is picking winners and losers on its platform, a system that might appear ripe for corruption and unjustified self-preferencing. But there are several reasons to believe this is not the case. Amazon has built a reputation of low prices, quick delivery, and a high level of customer service. This reputation provides the company an incentive to ensure a consistently high level of quality over time. As Amazon increases the number of products and services offered on its platform, it also needs to devise ways to ensure that its promise of low prices and outstanding service is maintained.

This is where the Buy Box comes in to play. All sellers on the platform can sell without utilizing the Buy Box. These transactions occur either on the seller’s own storefront, or by utilizing the “other sellers” portion of the purchase page for a given good. Amazon’s PPC does not affect the way that these sales occur. Additionally, the seller is free in this type of transaction to sell at whatever price it desires. This includes severely under- or overpricing the competition, as well as breaking price parity. Amazon’s policies do not directly determine prices.

The benefit of the Buy Box—and the reason that an IPPC can be so effective for buyers, sellers, and the platform—is that it both increases competition and decreases search costs. For sellers, there is a strong incentive to compete vigorously on price, since that should give them the best opportunity to sell through the Buy Box. Because the Buy Box is algorithmically driven—factoring in price parity, as well as a few other quality-centered metrics (reviews, shipping cost and speed, etc.)—the featured Buy Box seller can change multiple times per day.

Relative prices between sellers are not the only important factor in winning the Buy Box; absolute prices also play a role. For some products—where there are a limited number of sellers and none are observing parity or they are pricing far above sellers on other platforms—the Buy Box is not displayed at all. This forces consumers to make a deliberate choice to buy from a specific seller as opposed to from a preselected seller. In effect, the Buy Box’s omission removes Amazon’s endorsement of the seller’s practices, while still allowing the seller to offer goods on the platform.

For consumers, this vigorous price competition leads to significantly lower prices with a high level of service. When a consumer uses the Buy Box (as opposed to buying directly from a given seller), Amazon is offering an assurance that the price, shipping, cost, speed, and service associated with that seller and that good is the best of all possible options. Amazon is so confident with its  algorithm that the assurance is backed up with a price guarantee; Amazon will match the price of relevant competitors and, until 2021, would foot the bill for any price drops that happened within seven days of purchase.

For Amazon, this commitment to low prices, high volume, and quality service leads to a sustained strong reputation. Since Amazon has an incentive to attract as many buyers and sellers as possible, to maximize its revenue through commissions on sales and advertising, the platform needs to carefully curate an environment that is conducive to repeated interactions. Buyers and sellers come together on the platform knowing that they are going to face the lowest prices, highest revenues, and highest level of service, because Amazon’s implicit price-parity clause (among other policies) aligns incentives in just the right way to optimize competition.

Conclusion

In some ways, an implicit price-parity clause is the Goldilocks of vertical price restraints.

Without a price-parity clause, there is little incentive to invest in the platform. Yes, there are low prices, but a race to the bottom may tend to lead to a single monopolistic platform. Additionally, consumer welfare is not maximized, since there are no services provided at an efficient level to bring additional value to buyers and sellers, leading to higher quality-adjusted prices. 

Under a strict price-parity clause, there is a strong incentive to invest in the platform, but the nature of removing selling rights due to a violation can lead to reduced price competition. While the quality of service under this system may be higher, the quality-adjusted price may remain high, since there are lower levels of competition putting downward pressure on prices.

An implicit price-parity clause takes the best aspects of both no PPC and strict PPC policies but removes the worst. Sellers are free to set prices as they wish but have incentive to comply with the policy due to the additional benefits they may receive from the Buy Box. The platform has sufficient protection from free riding due to the revocation of certain services, leading to high levels of investment in efficient services that increase quality and decrease quality-adjusted prices. Finally, consumers benefit from the vigorous price competition for the Buy Box, leading to both lower prices and higher quality-adjusted prices when accounting for the efficient shipping and fulfilment undertaken by the platform.

Current attempts to find an antitrust violation associated with PPCs—both implicit and otherwise—are likely misplaced. Any evidence gathered on the market will probably show an increase in consumer welfare. The reduced search costs on the platforms alone could outweigh any alleged increase in price, not to mention the time costs associated with rapid processing and shipping.

Further, while there are many claims that PPC policies—and high commissions on sales—harm sellers, the alternative is even worse. The only credible counterfactual, given the widespread permeation of PPC policies, is that all sellers on the Internet only sell through their own website. Not only would this increase the cost for small businesses by a significant margin, but it would also likely drive many out of business. For sellers, the benefit of a platform is access to a multitude (in some cases, hundreds of millions) of potential consumers. To reach that number of consumers on its own, every single independent seller would have to employ a team of marketers that rivals a Fortune 500 company. Unfortunately, the value proposition is not on its side, and until it is, platforms are the only viable option.

Before labeling a specific contractual obligation as harmful and anticompetitive, we need to understand how it works in the real world. To this point, there has been insufficient discussion about the intra-platform competition that occurs because of price-parity clauses, and the potential consumer-welfare benefits associated with implicit price-parity clauses. Ideally, courts, regulators, and policymakers will take the time going forward to think deeply about the costs and benefits associated with the clauses and choose the least harmful approach to enforcement.

Ultimately, consumers are the ones who stand to lose the most as a result of overenforcement. As always, enforcers should keep in mind that it is the welfare of consumers, not competitors or platforms, that is the overarching concern of antitrust.

In Amazon, Antitrust & Competition, Platforms, Price Discrimination, Resale Price Maintenance , , , ,
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Kolasky (2) on the Apple e-books case: Coordination, even horizontal coordination, isn’t per se illegal

William J. Kolasky —  16 February 2016

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.

In Antitrust & Competition, Apple, Justice Department, Monopolization, Platforms, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , ,
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Reed on the Apple e-books case: “We can remember it for you wholesale” – why the model matters in Apple e-books

totmauthor —  16 February 2016

By Morgan Reed

In Philip K. Dick’s famous short story that inspired the Total Recall movies, a company called REKAL could implant “extra-factual memories” into the minds of anyone. That technology may be fictional, but the Apple eBooks case suggests that the ability to insert extra-factual memories into the courts already exists.

The Department of Justice, the Second Circuit majority, and even the Solicitor General’s most recent filing opposing cert. all assert that the large publishing houses invented a new “agency” business model as a way to provide leverage to raise prices, and then pushed it on Apple.

The basis of the government’s claim is that Apple had “just two months to develop a business model” once Steve Jobs had approved the “iBookstore” ebook marketplace. The government implies that Apple was a company so obviously old, inept, and out-of-ideas that it had to rely on the big publishers for an innovative business model to help it enter the market. And the court bought it “wholesale,” as it were. (Describing Apple’s “a-ha” moment when it decided to try the agency model, the court notes, “[n]otably, the possibility of an agency arrangement was first mentioned by Hachette and HarperCollins as a way ‘to fix Amazon pricing.'”)

The claim has no basis in reality, of course. Apple had embraced the agency model long before, as it sought to disrupt the way software was distributed. In just the year prior, Apple had successfully launched the app store, a ground-breaking example of the agency model that started with only 500 apps but had grown to more than 100,000 in 12 months. This was an explosion of competition — remember, nearly all of those apps represented a new publisher: 100,000 new potential competitors.

So why would the government create such an absurd fiction?

Because without that fiction, Apple moves from “conspirator” to “competitor.” Instead of anticompetitive scourge, it becomes a disruptor, bringing new competition to an existing market with a single dominant player (Amazon Kindle), and shattering the control held by the existing publishing industry.

More than a decade before the App Store, software developers had observed that the wholesale model for distribution created tremendous barriers for entry, increased expense, and incredible delays in getting to market. Developers were beholden to a tiny number of physical stores that sold shelf space and required kickbacks (known as spiffs). Today, there are legions of developers producing App content, and developers have earned more than $10 billion in sales through Apple’s App Store. Anyone with an App idea or, moreover, an idea for a book, can take it straight to consumers rather than having to convince a publisher, wholesaler or retailer that it is worth purchasing and marketing.

This disintermediation is of critical benefit to consumers — and yet the Second Circuit missed it. The court chose instead to focus on the claim that if the horizontal competitors conspired, then Apple, which had approached the publishers to ensure initial content would exist at time of launch, was complicit. Somehow Apple could be a horizontal competitor even through it wasn’t part of the publishing industry!

There was another significant consumer and competitive benefit from Apple’s entry into the market and the shift to the agency model. Prior to the Apple iPad, truly interactive books were mostly science fiction, and the few pilot projects that existed had little consumer traction. Amazon, which held 90% of the electronic books market, chose to focus on creating technology that mirrored the characteristics of reading on paper: a black and white screen and the barest of annotation capabilities.

When the iPad was released, Apple sent up a signal flag that interactivity would be a focal point of the technology by rolling out tools that would allow developers to access the iPad’s accelerometer and touch sensitive screen to create an immersive experience. The result? Products that help children with learning disabilities, and competitors fighting back with improved products.

Finally, Apple’s impact on consumers and competition was profound. Amazon switched, as well, and the nascent world of self publishing exploded. Books like Hugh Howey’s Wool series (soon to be a major motion picture) were released as smaller chunks for only 99 cents. And “the Martian,” which is up for several Academy Awards found a home and an audience long before any major publisher came calling.

We all need to avoid the trip to REKAL and remember what life was like before the advent of the agency model. Because if the Second Circuit decision is allowed to stand, the implication for any outside competitor looking to disrupt a market is as grim and barren as the surface of Mars.

In Amazon, Antitrust & Competition, Apple, Monopolization, Platforms, Resale Price Maintenance, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Telecommunications, Vertical Restraints, Wireless , , , , , , , , , , , , , , , ,
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Hazlett on the Apple e-books case: The Apple case is a throwback to Dr. Miles, and that’s not a good thing

totmauthor —  16 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Justice Department, Law & Economics, Monopolization, Platforms, Resale Price Maintenance, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , , , ,
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Sagers on the Apple e-books case: Why does everybody hate competition so much?

Chris Sagers —  16 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Law & Economics, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , , ,
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Day two of TOTM’s blog symposium on the Apple e-books antitrust case

Geoffrey Manne —  16 February 2016

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.

In Announcements, Antitrust & Competition, Apple, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , ,
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Balto on the Apple e-books case: Skip the (Apple) appetizer and get to the (McWane) main course

David Balto —  15 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Exclusive Dealing, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , , , ,
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Hylton on the Apple e-books case: The central importance of the Court’s under-appreciated Business Electronics case

Keith Hylton —  15 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , ,
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Albanese on the Apple e-books case: Apple’s Anticlimactic Appeal

totmauthor —  15 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , ,
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Manne on the Apple e-books case: The Second Circuit’s decision has no support in the law and/or economics

Geoffrey Manne —  15 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Economic Theory, Intellectual Property, International Center for Law & Economics, Law & Economics, Monopolization, Patent, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , , , , , ,
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Jacobson on the Apple ebooks case: It is hard to find an easier antitrust case than United States v. Apple

Jonathan M. Jacobson —  15 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Monopolization, Platforms, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , ,
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Abbott on the Apple e-books case: Apple v. United States and antitrust error cost analysis

Alden Abbott —  15 February 2016

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.

In Amazon, Antitrust & Competition, Apple, Error Costs, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , ,
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