Competition and innovation

Competition and innovation Alberto Heimler Scuola Nazionale dell’Amministrazione

Whatiscompetition? • Steve Jobs once said, “you can't look at the competition and say you're going to do it better; you have to look at the competition and say you're going to do it differently” • Competition is rivalry. • But rivalry for what?

Whatis the purpose of competition law? • Maximization of total welfare? • Competitionauthorities do notseem to followit • Maximizationof consumer welfare? • Whynot introduce a cap on profits? • Fairness? • Verydiscretionary and subjective • Protection of sunkinvestments?

Antitrust prohibitions; are theyinnovationfriendly? • The abuse of a dominant position:the Microsoft and Google cases • Agreements that restrict competition; credit cards and Booking.com • Merger control: Facebook-WhatsApp

Article 102 • Article 102 of the EU Treaty prohibits abuse of dominance. The article contains a list of not exhaustive possible abusive practices put in place by a dominant firm: (a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions; (b) limiting production, markets or technical development to the prejudice of consumers; (c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; (d) making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts • Every example refers to the prohibited practice and contains its defense.

Explicit Refusal to deal 1/6 • One of the fundamental principles of a market economy is the freedom to deal. A duty to deal modifies the incentives to invest. • Firms have always the incentive to maximize sales, given prices, and every refusal to deal with a customer has a good reason, for example that the firm does not have enough capacity or that the customer is likely not to pay. • Refusal to deal is an abuse only if directed towards a competitor. In that case the duty to deal protects the competitive process and consumer welfare. Sometimes the refusal to deal is directed towards a customer, but only because as result a competitor is excluded: • In the United Brands judgment, the Court has considered abusive refusing to deal with Olesen, a Danish distributor that had participated in an advertising campaign launched by a United Brands competitor. Refusing to deal with that customer was meant to exclude a competitor and strengthen the dominant position of United Brands on the banana market.

Explicit Refusal to deal 2/6 • Refusing to deal with a competitor is abusive when a firm that controls an input essential to operate in a downstream market where it also operates refuses to deal with competitors excluding them from that downstream market, damaging consumers. The approach was developed for the first time in the 1974 Commercial Solvents decision: • Commercial Solvents refused to continue to supply to Zoja, an Italian producer of drugs, aminobutanol, an essential input for the production of drugs against TBC, a market where also ICI was operating, a company controlled by Commercial Solvents. In the Judgment confirming the Commission decision the Court maintains: “an undertaking which has a dominant position in the market in raw materials and which, with the object of reserving such raw material for manufacturing its own derivatives ,refuses to supply a customer, which is itself a manufacturer of these derivatives, and therefore risks eliminating all competition on the part of this customer, is abusing its dominant position within the meaning of Article 86 (102)”

Oscar Bronner (1998) 3/6 • The Court maIntains that a refusal to deal is abusive when its is “likely to eliminate all competition in the (...) market (...) and that [it is ...] incapable of being objectively justified, but also that the [refused] service (...) be indispensable to carrying on that person's business, inasmuch as there is no actual or potential substitute” • In the specific case the Court concluded that the refusal was justified. “Indispensable” is a very rigorous standard. Furthermore the Commission did not say what a company has to do in order to give access (what prices what conditions etc.) • In practice access has to be objectively necessary and there is a high probability that the refusal leads to the elimination of competition on the relevant market (Guidance).

Refusal to deal in the US: quasi legality 4/6 • In Trinko v. Verizon (2004) the Supreme Court held that when a binding regulatory obligation to deal is in place and at a price reflecting long-run incremental costs, refusal to deal should not be considered an antitrust law violation. • After Trinko people have concluded that refusal to deal by dominant players will always be legal in the US. For example Eleanor Fox suggests that “Trinko has … opened wide the door to argument … that the starting point is scepticism about Section 2 based on fear that courts will condemn ambiguous conduct that is in fact efficient”. • The Supreme Court suggests that a regulated monopolist is not subject to an antitrust obligation to deal. The Court does not tells us under what conditions such an obligation to deal actually exists, if ever.

Magill (1995) and IMS Health (2004) 5/6 • For a refusal to licence to be abusive above the Oscar Bronner conditions (likely to eliminate all competition in the (...) market (...) and that [it is ...] incapable of being objectively justified, but also that the [refused] service (...) be indispensable to carrying on that person's business, inasmuch as there is no actual or potential substitute), it is necessary that because of the refusal a new product for which there is demand is denied to consumers. • What is a new product In the case of Magill it was the weekly TV guide, in the case of IMS the product does not seem that different from the one IMS was supplying. However since IMS is a referral case the Court leaves the issue to the domestic judge.

Microsoft 2004 6/6 • Refusal by Microsoft to provide competitors with information relating to its operating system source code which, it was alleged, was necessary for the development of competing software products. • Although the relevant information was protected by intellectual property rights, the Commission considered it essential for allowing the development of competing applications so that they could run smoothly on Windows. • The Commission found that there was no substitute for the IP protected product in the relevant market and that no satisfactory business justification for the exclusion had been shown. The new product standard has not been considered explicitly in the Commission's decision.

Microsoft case 1/3 • According to the Commission :“ the information to be provided should allow smooth interoperability and be priced reasonably” • After a long negotiation in 2007 the Commission accepts that a 10000 EUR flat fee is reasonable. Nonetheless the Commission gives Microsoft an 899 million EUR fine for the 3 years delay in respecting its 2004 decision • The Commission decision contains a very detailed analysis of what is innovative and whether the information to be provided should be priced. The decision however does not explain why 10000 EUR is reasonable, while 20000 EUR or 5000 EUR would not be.

Microsoft case 2/3 • In 2012 the General Court confirms the decision of the Commission • The Court does not discuss what is a reasonable price nor whether a reasonable price for access would promote competition in the market where Microsoft is dominant • Geradin e Rado maintain that FRAND royalties should not be imposed as an antitrust remedy in abuse cases because “Calls for antitrust intervention reflect a preference for a system of pervasive royalty regulation based on a flawed royalty-allocation mechanism that would inevitably hinder innovation.” • Antitrust should be concerned with exclusion not with reasonableness. The price to be paid should be non exclusionary.

Microsoft case 3/3 • Elhauge (2002) suggested that consumer benefits be calculated in an objective way and that pure bundling should be prohibited when it excludes an equally efficient competitor and its technological benefits are not demonstrated. Difficult and discretionary to apply • The EC Media player decision makes it mandatory to offer also an unbundled version of the Windows package. Such unbundled version should be priced at P minus avoided costs. Entry would occur in the case competitors develop a superior product. Otherwise why should they enter? • Marginal costs are zero. In order to promote entry prices should be imposed in proportion to developing costs (Scherer, 2008) • The Commission decision says nothing on prices, not even that they should be reasonable!

EU Google cases • The EuropeanCommissionallegedthat Google forcedAndroidphonemanufacturers (OEMs) to install Google Searchiftheywanted to install Google Play, an extremelydesirable, almostindispensable, application for phonemanufacturersbecauseitfacilitates downloading and updatingAndroidapplications. • Additionally, Google imposeduniformity: ifSamsung installs Google Play in one line of phones, Google requiresit to install Google Search in allitsphones • Furthermore the EuropeanCommissionallegedthat Google favoreditsaffiliates in Internet search. Ifyousearch for “New York Denver flights” in Google, youget a result from “Google flights,” a Google affiliate, at the top of the page and not from Orbitz, Expedia or Kayak.

EU legal provisions on restrictive agreements • European legal provisions matter. • Article 101.3 requires that an agreement can be exempted if leads to innovation, a fair share of the benefits goes to consumers, it is indispensable and competition is not eliminated. • Accordingly, THE COUNTERFACTUAL IS NOT THE ABSENCE OF THE AGREEMENT (as it should be) BUT A DIFFERENT LESS RESTRICTIVE AGREEMENT

Credit cards • Issuing institutions receive the interchange fee. Competition between them leads them to compete it away by returning it to consumers • Indeed in the US the 10 most convenient cards give back to consumers most of their extra-profits, while retailers continue to pay the merchant fee. The market is innovation friendly! • In Europe not much competition between cards and between acquiring banks. So antitrust authorities stepped in to reduce the interchange fee for retailers. Similarly to what happened in the US with the Durbin Amendment for debit cards. In the US the level of the fee to retailers is not considered an issue to be concerned about because innovation may compete it away.

Booking.com • Platforms imposed price parity constraints on hotels. National competition authorities in the EU prohibited price parity across platforms. • Nothing prevents platforms to reduce fees and/or give back to customers part of the fee via discounts. • How does competition operate in this market? Platforms compete by reducing prices of single rooms at specific dates? Or do they compete by inducing loyalty in their customers (discounts or other services)? • The fact that a platform claims to have the lowest possible prices increases its attractiveness. • Plus, price comparators make competition on prices quite unlikely

Merger control: Facebook-WhatsApp, Facebook • Founded 4 February 2004.It offers a range of social services, incl. consumer communications and photo/video sharing to consumers and advertisers. Platforms: “Facebook”; “Facebook messenger”, and Instagram (photo/video sharing platform, acquired in 2012, 1 billion dollar). • Facebook social networking platform has 1.3 billion users worldwide, 300 million which are also users of Facebook Messenger app. It sells data to advertisers WhatsApp • Founded: 24 February 2009. It is a provider of a messaging and phone service app and is not available on PCs and tablet. It has 600 million users worldwide. (expected to become 1 billion by 2019). It sells its services in some countries.

The deal • Whatsapp has been acquired by Facebook for 19 billion dollar: • 4 billion in cash; • 12 billion worth in Facebook shares; • 3 billion worth in restricted stock. • Jan Koum joins the board of directors of Facebook.

Objectives of the acquisition as reported in newspapers • WhatsApphasboth offensive and defensivevalue to Facebook.Itis the fastest-growing company in history (in terms of users). If the company's growth continues, and it can continue to "monetize" its users, it will be worth an even more mind-boggling amount of money someday. The acquisition prevents WhatsApp from becoming the Facebook of the future • WhatsApp'sgrowth and usageisabsolutelystaggering: FacebookthinksWhatsAppcouldhave 1 billionusers in a fewyears, and this estimate seems conservative. (Facebookitselfhasonly 1.2 billionusers.). Whatsappmightbecome the next-facebookasitalreadydoesmuch more than mere text- messaging and call services • WhatsApphasverylowcosts: ithasonly 55 employees • Mostpeoplehaveconsistentlyunderestimated the power, growthpotential, and value of the leading social platforms, includingFacebook. Facebookisnowvaluedat$200 billion. • (source business insider, 20 feb 2014, henry blodget)

Relevant market: digital messages • In EEA Facebook messenger (10-20%); WhatsApp (20-30%). Combined share 30-40%. Market share is usually calculated on the basis of revenue from sales. In this case not possible. Commission accepted the method of Facebook on “reach data”, i.e. the percentage of users who have used a certain consumer app over 30 days. • There are many competitors in this market

Relevant market: Communication apps • Facebook messenger and WhatsApp are not close competitors; • After the merger, there remain alternatives. Furthermore, customers can easily switch between app. providers; • There are no significant "traditional" barriers for a new consumer communications app to enter the market, that is, to be offered to users for download;

Relevant market: Social networking • If the potential market for social networking services includes consumer communications apps such as WhatsApp, there are a significant number of alternative service providers, which are used by consumers interchangeably; • Given the considerable differences between the functionalities and focus of WhatsApp and Facebook, the Commission concludes that these providers are not close competitors in the potential market for social networking services. • Even in the event of integration between whatsApp and Facebook, the net-gain in terms of new members of social network would be limited, since user base of WhatsApp already overlaps to a significant extent with that of Facebook. Facebook and Whatsapp are complementary services

Relevant market: Online advertising • Regardless of whether the merged entity will introduce advertising on WhatsApp, there will continue to be a sufficient number of other actual and potential competitors who are equally well placed as Facebook to offer targeted advertising; • Regardless of whether the merged entity will start using WhatsApp user data to improve targeted advertising on Facebook's social network, there will continue to be a large amount of Internet user data that are valuable for advertising purposes and that are not within Facebook's exclusive control;

Outcome • According to the analysis briefly outlined the merger was authorized by the Commission on November 21 2014 • But the 2010 US merger guidelines suggest that, in addition to price effects, “[e]nhanced market power can also be manifested in non-price terms and conditions that adversely affect customers, including reduced product quality, reduced product variety, reduced service, or diminished innovation”. • How to assess the relevance of non price effects in merger control is the challenge for the future

Conclusions • Antitrust rules are well designed. Except for the “indispensability” concept in article 101.3. But interpretation can indeed help in overcoming a too formalistic approach • Especially on remedies in abuse cases the two sides need to be considered (quantities and prices). • On merger control technological development has made competition much more elusive and concepts like markets, prices, market power are much more difficult to be defined. • Non price effects in merger control may become more important, but we need a more rigorous approach on the type of analysis to be undertaken

Competition and innovation