Assessing Less Restrictive Alternatives and Interbrand Competition in Epic v Apple - International Center for Law & Economics
Focus Areas:    Antitrust | Apple | Competition

Assessing Less Restrictive Alternatives and Interbrand Competition in Epic v Apple

Truth on the Market View Original

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

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

Introduction

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

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

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

Competitive Effects in Two-Sided Markets

Two-sided markets connect distinct sets of users whose demands for the platform are interdependent—i.e., consumers’ demand for a platform increases as more products are available, and conversely, product developers’ demand for a platform increases as additional consumers use the platform, increasing the overall potential for transactions. As a result of these complex dynamics, conduct that may appear anticompetitive when considering the effects on only one set of customers may be entirely consistent with—and actually promote—healthy competition when examining the effects on both sides.

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

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

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

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

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

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

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

Less Restrictive Alternatives and the Rule of Reason

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

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

According to Epic, because the district court identified some anticompetitive effects on one side of the market, and because alternative business models could, in theory, be implemented to achieve the same procompetitive benefits as Apple’s current business model, the court should have ruled in Epic’s favor at step three.

There are several problems with this.

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

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

While, following the Supreme Court’s recent Alston decision, LRA analysis may well be appropriate in some contexts to identify anticompetitive conduct in the face of procompetitive justifications, there is no holding (in either the 9th Circuit or the Supreme Court) requiring it in the context of two-sided markets. (Amex refers to LRA analysis as constituting step three, but because that case was resolved at step one, it must be viewed as mere dictum).And for good reason. In the context of two-sided platforms, an LRA approach would inevitably require courts to second guess the particular allocation of costs, prices, and product attributes across platform users. As Tom Nachbar writes:

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

Moreover, LRAs—like the ones proposed by Epic—that are based on maximizing competitor effectiveness by “opening” an incumbent’s platform would convert the rule of reason into a regulatory tool that may not promote competition at all. As Alan Devlin deftly puts it:

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

Open Platforms Are not Necessarily Less Restrictive Platforms

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

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

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

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

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

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

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

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

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

Conclusion

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

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

Amici Scholars Signing on to the Brief

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

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