May 1, 2014

BARELY LEGAL: The Antitrust Economics of Free Software: Can Firms Evade Antitrust Scrutiny by Selling Apps for Free?

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By MINSUK HAN

Last February, when Facebook Inc. announced that it would acquire WhatsApp Inc. for $19 billion, few antitrust experts suspected that the proposed acquisition would face a serious challenge from government authorities.  There seemed to be no apparent competition issues in the dynamic market for free mobile messaging apps.

When services and goods are sold for free, there is usually a complimentary product from which the firm makes profits.  Facebook apps and services are all free for most of us, but they sell spaces on our Newsfeeds to advertisers at a high price.  Because these firms serve two distinct groups of customers — end users on one side and advertisers on the other side — they are often called  “two-sided platforms.”

These two-sided platforms are becoming the major business strategy in the mobile app market.  Because the price is zero on one side of the platform, however, two-sided platforms present a challenge to antitrust analysis, which has traditionally assumed that goods are sold at a price higher than zero.

For example, the Section 7 of the Clayton Act prohibits mergers and acquisitions that may substantially lessen competition or tend to create a monopoly.  When evaluating the possible anticompetitive effects of a proposed transaction, we use the Hypothetical Monopolist Test to define “the relevant market.”  The Test supposes a scenario in which there is no competition for a given product— suppose all firms selling product X merge into one firm.  We then ask if that “hypothetical monopolist” could profitably increase the price of product X by a certain small but significant amount (usually five to 10 percent) without losing customers to other products, like product Y.  If such a hypothetical monopolist could profitably raise its price, product X constitutes a relevant market and we analyze the anticompetitive effect of the proposed merger within that market.  If, hypothetically, the one and only seltzer producer can profitably raise its price by 10 percent without losing customers to others (like spring water producers), seltzer water may constitute a relevant market by itself.  If not, we might have to include spring water in the defined market.  The market definition is often a critical issue because the narrower the relevant market is, the more likely that a proposed horizontal merger would be found anticompetitive in violation of the Clayton Act.

However, if the base price of a product is zero, we cannot define the relevant market using the Hypothetical Monopolist Test because we cannot increase the price of zero by a certain amount.  For this reason, scholars have suggested that when two-sided platforms are involved, the relevant market should consist of firms operating on both sides of the platform, and the market power analysis should take into account the economic interdependence of the two sides. Therefore, if we were to analyze the social networking services market, not only do we have to consider how much web traffic Facebook, MySpace and Twitter draw, but also look into the advertising side of their business.

The problem becomes even more complicated if a firm has more than two groups of customers whose economic interdependence is intricately intertwined. Google’s Android business is a good example. Google developed Android, a free, fully open-source mobile software platform that any device manufacturers can install on a device and any software developers can use to create apps. Google does not charge Samsung for powering all the Galaxy S smartphones. Indeed, Google takes a cut from app sales on Google Play, Google’s version of App Store, but not all Android devices are compatible with Google Play. For Google, the Android project is more about making a defensive move in the still nascent mobile device ecosystem — Google is afraid that users are accessing more and more information directly from a content provider without using search engines.  Android will help Google find ways to keep mobile web traffic under control so that it can maintain its dominance in the advertising market.

Therefore, with its Android business, Google is serving several distinct groups of customers, creating a four-sided platform: 1) mobile device manufacturers like Samsung, which can always choose to install another operating system such as Windows Phone or its own Tizen operating system on its Galaxy devices; 2) software developers like Rovio, which can always make their new Angry Birds game available only on iPhones; 3) advertisers, which can always choose to advertise only on Yahoo or Bing; and finally 4) end users, who can always choose not to use Google to “google.”

If Google were to buy the Windows Phone 8 operating system from Microsoft to create Windroid, which would be offered to mobile phone manufacturers on the same terms under which it has offered Android, would Google be violating the U.S. antitrust laws?  Should it be?

The antitrust analysis of this hypothetical acquisition under current doctrine would be extremely complicated not only because the underlying product would be sold for free but also because the relationship among different sides of the business is not straightforward. Google’s advertising business is several steps removed from its business with mobile device manufacturers and software developers. This is unlike more common two-sided platforms such as free newspapers where the newspaper’s power over the advertising market is directly related to its readership.

As users get more and more accustomed to free services, firms in the innovation industries often employ very sophisticated business strategies, including multi-sided platforms. Unless we are equipped to properly analyze the antitrust implications of such business behavior by fully understanding those strategies, we might be letting firms evade antitrust scrutiny simply by selling products for free but still profiting somewhere else.

Minsuk Han is a third-year student at Cornell Law School.  He can be reached at mh945@cornell.edu. Barely Legal appears alternating Fridays this semester.

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