Archive for August, 2017

My Comment on Wright’s “Antitrust Provides a More Reasonable Framework for Net Neutrality Regulation”

Professor Josh Wright has written a piece that responds, at least in part, to my new article explaining why antitrust cannot accommodate net neutrality violations in particular, nor other mild forms of discrimination on the Internet in general. In his Perspective for the Free State Foundation, Wright argues that my analysis of the limits of antitrust as applied to this particular type of discriminatory conduct “reveal[s] a profound and fundamental lack of understanding of the rule of reason framework.” Ouch. As it turns out, Wright’s understanding of antitrust, as reflected in prior writings, is exceedingly narrow, which proves my point.

For those getting up to speed, my article makes two major points: (1) a pure innovation-based case that lacks short-run price and output effects—the types of antitrust injury that are readily cognizable and more easily proven—would be exceedingly difficult to win given prevailing evidentiary requirements under antitrust law; and (2) even if one could prevail on the merits of such a case, the practical difficulties for a private litigant to bring a pure innovation-based case, in terms of time and resources, renders antitrust ineffective in policing discrimination on the Internet.

Wright ignores the second point of my article entirely, focusing instead on the claim that antitrust does in fact recognize innovation-based harms. But the practical challenges to an antitrust approach cannot be ignored: The speed of decision-making in this arena is critical, and as demonstrated below, the Federal Trade Commission (FTC) has not shown it can move fast. Wright fails to appreciate that securing a lasting solution—dare I say legislative compromise—to the net neutrality problem requires offering a good-faith alternative to Title II-based rules that provides timely relief to edge providers. Telling an edge provider that it must endure a three-to-ten year adjudication process costing multiple millions of dollars fails that requirement.

With respect to the first point of my article, the cases Wright cites as evidence of the FTC’s willingness and ability to take on pure innovation (non-price) cases actually prove my point, since in each substantive discussion, the FTC cites higher prices as at least a partial basis for their requested relief. (And even if an agency would be willing to bring such a hypothetical case, Wright offers no prescription for how a private litigant could secure relief from discrimination.) None of the cases he cites serves as counterexamples to my claim that a pure innovation-based, single-firm monopolization case would not likely prevail under current antitrust standards. Deprived of any compelling counterexamples, Wright is left to cite an amicus brief by the FTC in Mylan.

In Intel, his best counterexample, Wright fails to note that the FTC pulled the plug by settling, which means the case has no precedential value for future plaintiffs. He also fails to note that the FTC’s theory of harm in Intel involved both short-run price effects and innovation harms. A quick review of the complaint reveals the FTC’s price-based theory of harm, demonstrating the case supports my theory, contrary to Wright’s claim:

  • “On the one hand, Intel threatened to and did increase prices, terminate product and technology collaborations, shut off supply, and reduce marketing support to OEMs that purchased too many products from Intel’s competitors.” (paragraph 6)
  • “Intel’s use of penalties, rebates, lump-sum and other payments across multiple products, differential pricing, and other conduct alleged in this Complaint maintained or is likely to maintain Intel’s monopoly power to the detriment of competition, customers, and consumers. Intel would not have been able to continue charging comparably higher prices across its product lines but for its conduct, as alleged in this Complaint, that harmed competition.” (paragraph 55)
  • “To combat this competition, Intel charged those OEMs significantly higher prices because they used a non-Intel graphics chipset or GPU.” (paragraph 89)
  • “Intel’s conduct adversely affects competition and consumers by, including but not limited to: causing higher prices of CPUs and GPUs and the products containing microprocessors;” (paragraph 94)
  • “Absent such relief, for OEMs and consumers of the relevant products, the consequences have been and likely will continue to be supracompetitive prices, reduced quality, and less innovation.” (paragraph 95)

Economists have demonstrated that, under certain conditions, share-based loyalty discounts can be used by monopolists to extract supra-competitive prices; when a firm enjoys monopoly power over a buyer’s initial requirements (or “noncontestable units”), the firm can offer to waive a “penalty price” on the noncontestable units in exchange for higher prices on the contestable units. Because Intel allegedly employed this precise strategy to secure higher chip prices, the case does not make for a good counterexample to my thesis regarding lax antitrust enforcement of pure innovation-based cases.

Wright cites Grifols, S.A. as an example of a “conduct case[] where the theory of harm was decreased innovation.” But Grifols arose in a merger context, where the theories of harm that an antitrust agency may pursue are arguably more expansive than those an agency can pursue in a single-firm monopolization case; merger review is made pursuant to Section 7 of the Clayton Act, whereas monopolization cases are pursued under Section 2 of the Sherman Act. Again, these are weak counterexamples.

Lastly, by citing Microsoft (a case that is nearly two decades old), Wright inadvertently proves my second point, which he is otherwise silent on: Antitrust generally, and the antitrust agencies specifically, are currently ill-equipped to effectively pursue a platform owner that commands sufficient market power to stifle innovation. While the Department of Justice arguably prevailed over Microsoft, it was unable to do so fast enough to save Netscape, the innovative browser company that was run over by Microsoft’s unlawful support of Explorer, its rival. (Rival chipmaker AMD similarly twisted in the wind for years while Intel was resolved.) That the FTC/DOJ have not litigated a major Section 2 case since Microsoft, certainly not one involving platform technologies, is remarkable. Until the FTC demonstrates a track record and the willingness to bring Section 2 cases, Wright’s arguments are nothing more than hollow promises.

In today’s global Internet marketplace, any delay of innovation in the United States will likely be countered by deployments of innovation elsewhere, disadvantaging U.S. companies and consumers. Attempting to address inequities in the fast-moving Internet space with the hoop-jumping required by the Administrative Procedure Act of 1946 and the Federal Trade Commission Act of 1913 is as nonsensical as trying to govern the Internet with the 1934 Communications Act, which even Wright agrees is in adequate for the Information Age.

Perhaps most surprisingly, Wright appears to abandon his prior stance that modern antitrust is ineffective in combatting a monopolist’s efforts to stifle innovation. In a 2010 publication titled Google and the Limits of Antitrust—the title says it all—Wright offers an exceedingly narrow view of antitrust. Wright and his co-author Geoff Manne are generally skeptical about the scope of antitrust enforcement as applied to platform providers such as Google. They conclude (page 74): “that plaintiffs cannot or should not prevail against Google in a monopolization claim based on the two types of conduct considered here: exclusive syndication agreements and use of the quality score metric to extract greater rents.” Given “the apparent lack of any concrete evidence of anticompetitive effects or harm to competition,” they argue, “an enforcement action against Google on these grounds creates substantial risk for a false positive which would chill the innovation and competition currently providing immense benefits to consumers.” It is not clear how a plaintiff could ever prove “concrete evidence anticompetitive effects” for an innovation-based harm that has not yet materialized.

Perhaps most revealing, Manne and Wright block quote (at page 63) the evidentiary standards from the Areeda-Hovenkamp treatise for exclusive dealing cases:

In order to succeed in its claim of unlawful exclusive dealing, a plaintiff must show the requisite agreement to deal exclusively and make a sufficient showing of power to warrant the inference that the challenged agreement threatens reduced output and higher prices in a properly defined market. Then it must also show a foreclosure coverage sufficient to warrant an inference of injury to competition, depending on the existence of other factors that give significance to a given foreclosure percentage, such as contract duration, presence or absence of high entry barriers, or the existence of alternative sources or resale.

The treatise does not say that a harm to innovation can be substituted for a showing of “reduced output or higher prices.” When it comes to exclusionary conduct, it’s all about the prices!

When the FTC appeared poised to file an antitrust complaint against Google, Manne and Wright issued a statement in June 2011 that succinctly reflected their views of the limits of antitrust: “The focus of any antitrust inquiry must always be on consumer harm—not harm to certain competitors. We are skeptical that any such harm can be proven here.” On this Wright and I agree: Under the consumer-welfare standard, discriminatory or exclusionary conduct by a platform provider that does not generate a price or output effect will largely go unchecked by antitrust law.

And that’s precisely the regulatory gap that my proposed tribunal seeks to fill. Under the consumer-welfare lens, the antitrust agencies and courts take a narrow approach to antitrust; until that changes, we cannot count on the FTC to police discrimination on the Internet.

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Why All-Inclusive Resorts Suck (And Why Prices Are a Great Thing)

I’m not a fan of all-inclusive resorts. Having just returned from one in Punta Cana (DR), which appears to offer over 100 all inclusives, the indignities suffered are fresh in my mind. Allow me to share my horror and impart a bit of economics.

The basic problem with all inclusives is vertical integration of hotels into restaurants. The lack of synergy between the two skill sets is made worse by the big bundle, which eliminates prices for the “tied” product—in this case, resort food and drinks.

Don’t mistake this as a rant against vertical integration generally. Some skill sets nicely complement each other. For example, local breweries tend to be good at making food, presumably because someone who has a knack for making tasty brews understands the palate. Economists call these “synergies,” and they should be exploited whenever possible.

I learned this lesson first hand at the Atlantis Resort in the Bahamas. Atlantis offers its own restaurants. It also (wisely) contracts out resort space to third-party restaurateur such as Nobu. Trust your fearless blogger when he tells you the homegrown resort food is barely edible. In contrast to our local brewery example, the skills sets of making elaborate water parks (or just plain swimming pools) and making cuisine simply don’t overlap.

(A quick econ digression: A seminal piece by Carlton (2001) shows how bundling by an all-inclusive resort also can be bad for island natives. Before the resort bundled food with hotel stays, there was a thriving sector of independent restaurateurs, which catered to both island natives and tourists. After the bundle is introduced, tourists now eat all of their meals “for free” at the resort—really at no incremental charge—driving the independents out of business due to a lack of viable scale. Island natives are suddenly beholden to a monopoly provider of restaurants. But this piece is trying to convince you that tourists like you are harmed as well!)

When mediocre, resort-owned restaurants and bars are not allowed to charge a price due to the all-inclusive bundle, the problem of vertical integration in the absence of synergies is exacerbated. Now the interests of the resort and the guests are almost perfectly in conflict—the resort’s new profit objective is to minimize expenditure on food and drink given their zero incremental contribution to margin. And the guests can’t buy their way out of the predicament.

Even when something is “free” for guests at the margin, so long as there is a cost to provide the good (a meal or a drink), the supplier will find a way to ration supply. This is the role normally reserved for prices. But all inclusives kill the normal market mechanism.

In the case of an all-you-can-drink poolside bar—a cool idea in theory once you get over where guests are urinating—that means understaffing the bar so that patrons tread water for long periods before getting the bartender’s attention.

Rationing can also be achieved by decreasing the quality of spirits. Put bluntly, this entails cheating their guests. Stock the crummiest wine possible: Call one “white” and the other “red.” The all inclusive at which I stayed offered one red, one white, and one beer (Presidente). You should have seen the bartender’s expression when I asked for an Old Fashioned with Rye.

At the extreme end of the cheating spectrum, look to the Spanish chain Iberostar, an all-inclusive resort that substituted bootleg liquor for the real stuff across several properties in Mexico, and sent several guests to the hospital and some to their death. (When I fumed on Twitter the other day, Iberostar responded by saying: “We only purchase sealed bottles that satisfy all standards required. Safety and satisfaction of our guests is of utmost importance for us.” Hope they have a better defense in court!)

The same incentives apply to all-inclusive resort food. None of these outfits could survive outside of the resort. I met some New Yorkers who paid a hotel chain $1,500 on day three of their vacation to move from one resort to another (mine), because their family could not stomach the grub at the original resort. They literally upgraded from horrible to not horrible.

In addition to suffering low quality and long queues, guests at an all inclusive cannot incentivize staff via tipping. When you pay for drinks on the beach a la carte, you can add a gratuity at the end of your experience when presented with the bill. The next day your friendly server will remember the tip, and (hopefully) give you the royal treatment. Sometimes the gratuity is even already added to the bill. But at the all-inclusive resorts, because guests are not presented with a bill, the only way to tip your server and thus incentivize him is with cash. But who swims with cash in their pockets?

Are you convinced that prices are wonderful? Of course, charging a positive price at the margin for booze has a drawback, in that it causes guests to drink too little relative to the socially optimal level. Resorts make more money the more you drink, and your friends have more fun (making fun of you) the more you drink. But good resorts that offer food and drink a la carte know how to solve that problem—namely, by giving away free drinks.

“Hold on one second,” my free-market friends insist. “All inclusives are sensitive to the reputational costs of driving away repeat business. There must be at least some all-inclusives that have built up a brand name, have a lot of loyal repeat customers, care about their reputation, and treat their loyal customers well. They follow an all-inclusive model not to screw their customers, but to guarantee an all-around high quality experience.”

If only. The all inclusives rely on a steady supply of myopic, one-shot guests. Sure there are loyalists, but by repeatedly withstanding these indignities, they have revealed that they either don’t put a premium on food—did I mention there was free booze?—or don’t know good food from bad food. And economists like Gabaix and Laibson (2006) have shown that firms would find it more profitable to pursue a pricing strategy that exploited myopic consumers with higher prices than to attempt to steal customers from one another by slashing prices of ancillary services, even in “highly competitive markets.”

There. I’m done with that rant. And I’m also done with all inclusives.

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