Antitrust action against Apple by the U.S. Department of Justice and 15 states may help some competitors, but is bad for consumers. (Commentary)
by Tracy Miller
On March 21, the U.S. Department of Justice (DOJ), along with attorneys general from 15 states and D.C., filed a lawsuit against Apple for monopolizing the smartphone market—a violation of the Sherman Act. The complaint alleges that Apple maintains its monopoly “by selectively imposing contractual restrictions on, and withholding critical access points” to its smartphones from developers. The argument is that Apple’s practices lock consumers into using its smartphones—thereby enabling the company to charge higher prices, impose higher fees on developers and creators and discourage the use of alternative phones.
A couple of the allegations of the DOJ complaint, if true, may indicate that Apple’s actions interfere with competition in the smartphone market and are a violation of antitrust law. On balance, however, pursuing an antitrust case against Apple is likely to reduce competition in the market for mobile devices and hinder the growth and dynamism of the technology sector and of the U.S. economy in general. Although this case may help some of Apple’s competitors, it will make things worse for consumers.
Understanding Market Competition
First, we must understand the environment of economic competition that’s the background for this case and the players involved. Market competition is a dynamic process whereby firms seek to gain market share by continued efforts to improve the goods and services they offer, while keeping costs and prices down. If a firm does this well, its market share will likely increase, and the number of competitors may decrease. In technology platform markets, providing consumers with low-priced and high-quality goods and services that are continually being improved by innovation is best achieved by developing and offering a system of complementary products. Firms choose a business model based on what they discover about consumer preferences, often competing by emphasizing different mixes of benefits because of heterogeneity in consumer preferences. Some consumers prefer the more open ecosystem offered by Android phones, while other prefer the more closed iOS ecosystem. Consumers make tradeoffs between price, quality and other attributes such as data privacy.
In tech platform markets, high fixed costs mean that markets are often dominated by one or two large firms. But entrepreneurs are always looking for profitable opportunities to use their expertise to develop suites of products and compete by offering some combination of lower prices or better features than existing market leaders. Competition for the market is often more important than competition in the market. Developing and implementing a complex business model to successfully displace an existing dominant firm may take a competing firm many years. But the rewards of doing so are sufficiently large that a credible attempt can attract investment capital.
It is sometimes hard to distinguish between conduct that reflects competition on the merits and that which violates antitrust law by being anticompetitive, since success at either could result in a large market share. The distinction depends partly on a clear understanding of what a firm’s obligations are in dealing with rivals.
Firms develop and offer high-quality, innovative products because they can earn profits doing so. The more risks they take, the more they expect to be compensated when their risky actions bear fruit in terms of a large consumer demand. Since it is trying to earn a large return on its investments, we should not expect a firm to take actions that will give competing firms an advantage and that may result in it earning a lower profit. The economy works better in the long run when property rights are upheld and firms are free to make strategic decisions about the most profitable way to use the assets in which they have invested. Without that expectation, firms would make fewer risky investments and there would be fewer innovative products available at affordable prices.
An important consequence of dynamic competition is transformative changes involving novel product categories or ecosystems, such as electricity, automobiles and, more recently, smartphones. Small startup firms play an important role in this, but it is often the case that they rely on cooperation with large, established firms, which have the capacity and resources to support transformative innovations.
Antitrust Policy and the Consumer Welfare Standard
Passed in 1890, the Sherman Act is intended to promote competition by penalizing firms for monopolizing or attempting to monopolize a specific market. Companies that engage in actions or behavior that interfere with the process of competition are therefore subject to penalty. And over the past 40 years, antitrust policy in the U.S. has upheld the consumer welfare standard: Unless a practice that allegedly reduces competition can be shown to reduce consumer welfare, the practice is not considered to be a violation of the Sherman Act.
The DOJ complaint against Apple emphasizes a static view of consumer welfare rather than viewing competition as a dynamic process that enhances consumer welfare over time. In its complaint, the DOJ emphasizes that the goal of its case against Apple is “freeing smartphone markets from Apple’s anticompetitive and exclusionary conduct and restoring competition to lower smartphone prices for consumers, reducing fees for developers, and preserving innovation.” Although reducing prices, reducing fees and preserving innovation are certainly worthy goals, careful economic analysis suggests that while this case could contribute to achieving one or two of these goals, it is likely to have offsetting harmful long-run consequences that are bad news for consumers.
DOJ Allegations Against Apple
The DOJ makes a range of allegations against Apple that are worth examining. In its press release announcing its complaint, the DOJ emphasizes actions that Apple has taken to discourage the development or reduce the functionality of complementary products that might make it easier for consumers to switch to competing smartphone platforms, such as messaging apps and mobile cloud-streaming apps. It also accuses Apple of using its monopoly over smartphones to dominate the market for other goods and services that enhance user experience for its smartphones, such as apps that it sells through its App Store.
One allegation that may deserve antitrust scrutiny is that Apple has “degraded” the quality, privacy and security of third-party messaging apps installed on the iPhone, implying that Apple intentionally limits the features incorporated into those messaging apps to reduce the quality of communication with users of other platforms. Functionality is also limited when an iPhone user uses Apple Messages to send a message to a non-iPhone user. This would presumably discourage iPhone users, their families and close friends from switching to Android phones. If this is true, then Apple’s actions are arguably anticompetitive and reduce consumer welfare.
But it is important that those who adjudicate the case consider whether Apple’s primary reason for the contracts and technical arrangements it makes that limit access to or functionality of third-party apps is to provide benefits of some kind for iPhone users. If the app’s reduced functionality is a secondary consequence of a policy that serves some other purposes such as enhancing the privacy and security of iPhone users’ data, then it is not a violation of antitrust law.
The DOJ makes a similar accusation about smartwatches, accessories that typically must be paired with a smartphone. Apple’s smartwatch, the Apple Watch, is only compatible with the iPhone. Some users who might switch to an Android phone might prefer a smartwatch that is compatible with both kinds of phones. The DOJ contends that Apple uses its control of the iPhone operating system (iOS) to degrade the functionality of third-party smartwatches to discourage iPhone users from buying those watches, which would make it easier to switch away from iPhones.
A Defense of Apple’s Conduct
The DOJ also points to Apple’s exclusionary conduct in its App Store. But its control of app distribution enhances the safety of Apple’s ecosystem; one study finds almost 100 times as many security issues on Android compared with iOS devices.
The DOJ and other proponents of antitrust action against Apple have emphasized the problem of lock-in—once a consumer owns an Apple smartphone and starts accumulating complementary apps, it becomes increasingly costly to switch to a competing operating system. Thus, anything that Apple does to make its apps interoperate better with its phone than with competing phones could be construed as anticompetitive. But given limited investment funds, it is a sensible investment strategy for Apple to invest more in apps that will offer large benefits to users of its phone than it does in those that offer larger benefits to the users of competing phones.
As a general principle, Apple is not obligated by antitrust law to add features that “seamlessly inter-operate” with competitors’ products. Apple’s decision not to support super apps that are potential competitors may be intended to safeguard its return on other investments it has made in its ecosystem.
The DOJ is also critical of Apple’s approach to privacy and data security, claiming that Apple “wraps itself in a cloak of privacy, security, and consumer preferences to justify its anticompetitive conduct.” DOJ contends that despite promoting “the self-serving premise” that its products uniquely safeguard consumer privacy and data security, Apple selectively compromises the privacy of its users when doing so serves its financial interest. But the fact that promoting consumer privacy is self-serving is not a bug, but a feature of how competition works in a market economy. Even if Apple is not perfectly consistent in its pursuit of privacy for its users, its efforts to promote privacy have made it more difficult to track iOS users, something many of them have indicated they value by not opting into tracking.
As noted above, the fact that some of Apple’s practices appear to be welfare-reducing makes the DOJ feel it’s justified in pursuing a case against the company. Nevertheless, it is important to recognize that an outside agency or court has limited ability to identify the true purpose or impact of a company’s conduct. Given the trial-and-error nature of many business decisions, the decision-makers themselves might not always know the reason for pursuing a particular practice, other than that the company prospered following its implementation.
Another problem with pursuing a complaint against Apple is that even prior to the DOJ announcement, Apple was taking steps to change some of the practices that are the subject of the complaint. For example, later this year the company is planning to begin offering Rich Communication Services (RCS) support to the iPhone, which will enhance interoperability of third-party messaging apps that work like its Messages app and improve the quality of multimedia messages between iPhone and Android users. This decision may have been influenced by the European Union’s Digital Markets Act, which is being implemented this year, but it may also be an attempt to compete with other platforms that already support RCS.
Consequences of Antitrust Action Against Apple
An even bigger problem with antitrust action will occur if the DOJ wins the case and then requires changes in Apple’s business model. Interfering with Apple’s practices, which contribute to a curated experience and enhance data privacy and security for its customers, would degrade dynamic competition in the smartphone market.
More importantly, a DOJ victory could have widespread impacts on future growth of the economy as a whole. If a court affirms the DOJ’s authority to act as an arbiter among competing business models, the threat of antitrust scrutiny being applied to other successful firms could discourage entrepreneurs from developing innovative systems that would contribute to greater future prosperity.
The DOJ does not have a strong case against Apple, which must compete vigorously to maintain or increase its market share. Many consumers have demonstrated that they prefer Apple’s closed ecosystem and are willing to pay more to use an iPhone rather than an Android phone. And competition between Apple and Android and among components within each ecosystem is driving innovation that consumers can count on to improve the options available to them over time.
Originally published by Discourse. Republished with permission.
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