DOJ's Barnett Slams Europe on Antitrust, iPods and Single Firm Conduct Analysis

September 13, 2006. Thomas Barnett, the Assistant Attorney General in charge of the USDOJ's Antitrust Division, gave a speech titled "Interoperability Between Antitrust and Intellectual Property". He warned that "regulatory second-guessing of private firms' solutions to technological problems, which I perceive to be on the increase, threatens to harm the very consumers it claims to help".

He diplomatically did not mention the EU, Europe, France, or any EU state by name in the prepared text of his speech. However, the details of his speech, and recent actions in Europe, indicate that he directed his comments mainly at Europe for its abuse of governmental authority to damage competition and harm consumer welfare.

In particular, he slammed France and other European nations for faulty competition analysis, and misguided pursuit, of Apple for its development and sale of iPod devices and iTunes service.

Barnett (at right) said that the pursuit of Apple "provides a useful illustration of how an attack on intellectual property rights can threaten dynamic innovation." He added that this government conduct may have a "pernicious" effect; "if the government is too willing to step in as a regulator, rivals will devote their resources to legal challenges rather than business innovation".

Also, he did not discuss the EU's persecution of Microsoft. Nevertheless, this speech was another in a series of speeches by US officials criticizing Europeans for their handling of claims of anti-competitive behavior arising out of single firm conduct in developing and marketing new technologies.

He spoke at a conference hosted by the George Mason University School of Law titled "Managing Antitrust Issues in a Global Marketplace".

Barnett covered four main topics in his speech. First, he offered a theoretical overview of intellectual property, static competition, and dynamic competition. Second, he applied this theory to explain how the pursuit of Apple is harming competition and consumers. Third, he offered some general principles for antitrust regulators in cases involving single firm conduct in the tech sector. Finally, he addressed enforcement orders.

Intellectual Property, Static Competition and Dynamic Competition. He began with the statement that "Antitrust and intellectual property policy are complements in that both seek to create a set of incentives to encourage an innovative, vigorously competitive marketplace that enhances efficiency and improves consumer welfare."

He then addressed efficiency. He said that there are two kinds, static efficiency, "which occurs when firms compete within an existing technology to streamline their methods, cut costs, and drive the price of a product embodying that technology down to something close to the cost of unit production", and dynamic efficiency, which refers to "gains that result from entirely new ways of doing business".

He then explained that "antitrust law, with its focus on improving consumer welfare, has a keen interest in protecting innovation. Fostering innovation requires recognition of the benefits of dynamic efficiency and the dangers of focusing myopically on static efficiency."

He elaborated that "The same forces that yield the benefits of static efficiency -- conditions that encourage rivals quickly to adopt a new business method and drive their production toward marginal cost -- can discourage innovation (and thus dynamic efficiency) if the drive toward marginal costs occurs at such an early stage that it makes innovation uneconomical." (Parentheses in original.)

"Where innovation requires substantial up-front research and development (R&D) costs, a rational firm will elect not to innovate if it anticipates a selling environment that too quickly resolves to marginal cost of production. This problem is sometimes described as the need to recoup R&D costs and an expected profit sufficient to induce firms to direct their capital to risky R&D ventures." Barnett added that "Seen in this light, strong intellectual property protection is not separate from competition principles, but rather, is an integral part of antitrust policy as a whole."

He concluded that "IP rights should be seen as encouraging firms to engage in competition, particularly competition that involves risk and long-term investment. Properly applied, strong intellectual property protection creates the competitive environment necessary to permit firms to profit from their inventions, which encourages innovation effort and improves dynamic efficiency."

He quipped that when breakthrough inventions have occurred, governments may be tempted to "to carve up the benefits and spread them around the economy", like a cooked goose at Christmas dinner, but that this would be killing the proverbial goose that lays the golden eggs.

He then detailed some of the recent efforts in Europe to kill the goose.

Europe and Apple. He first reviewed the history of Apple's development of the iPod and iTunes over the years, how Apple responded to consumer demand in extending from the Mac platform to include the PC platform, and to adopt USB connection technology. He heaped praise on Apple for its innovation, its responsiveness to consumers, and its solving of the music piracy problem.

"You might think that by creating a product to which consumers have flocked of their own free will and by mitigating the piracy problem, Apple would be cheered for pioneering greater access to music. But you would be wrong." Barnett did not mention the France or any European nation by name. But, he stated that "Apple is now under assault in a number of jurisdictions on the grounds that iTunes is too dominant and does not ``interoperate´´ with devices other than iPods."

He said that "One recent law, for example, may require sales of music or video to operate across a wide range of devices and creates a government body that can require a digital music provider to turn over information relating to its ``technological measures´´ to the extent needed for interoperability with other devices. Some consumer protection agencies have announced that they are considering imposing similar measures through lawsuits. Interestingly, the interoperable song format that is advocated -- MP3 -- is a compressed format of generally lower fidelity than iTunes files."

He then analyzed and rebutted each of the economic rationales that have been advanced in support of this sort of regulation.

"So what consumer harm do these regulatory bodies seek to address?", Barnett asked rhetorically. "One theory is that consumers are locked into buying songs only from the iTunes service and that they will have to pay too high a price for iTunes songs. But there are two problems with this theory. First, consumers can upload other formats (CD-ROMs and MP3 files) to Apple's devices, so they do not have to buy from iTunes. And while it is true that Apple's digital rights management (DRM) software ensures that the first recording of a song downloaded from iTunes can only play on an Apple device, consumers can re-record an iTunes song in an MP3 format and play it on other devices; in sum, it is hardly clear that they are locked in. Second, it appears that Apple has been depressing per-song prices, not raising them."

The second theory is that "Apple is selling songs on the cheap but devices on the dear, and consumers are hurt because they are locked into buying the same expensive devices in the future. The cheap songs/expensive device model may indeed be Apple's strategy. But this type of business model has been criticized in the past because the cheap product was the one that was sold first -- think cheap razors and expensive replacement blades or cheap printers and expensive replacement ink. Apple's model is the opposite: consumers buy the expensive iPod device first, then have the option -- not the obligation -- to use the free iTunes software and buy the cheap iTunes songs."

The third theory is that "information just wants to be free". Barnett dismissed this utopian and anthropomorphic slogan with the observation that "information creators want to be paid -- they will not create without rewards." He added that "the difficulty of protecting digital information against easy, unlawful misappropriation underscores the need for measures to protect one's investments."

The fourth theory is that "Apple may not be hurting consumers, but it is hurting competitors." He noted that "Antitrust law protects competition, not competitors."

Barnett gave his speech on Wednesday, September 13. On September 14, Microsoft announced details of its competing Zune technology, which will compete with Apple's iPod and iTunes technology.

Microsoft stated in a release that Zune is its "music and entertainment platform that provides an end-to-end solution for Connected Entertainment. The Zune experience includes a 30GB digital media player, the Zune Marketplace music service, and a foundation for an online community that will enable music fans to discover new music."

Single Firm Conduct. Barnett also articulated three new principles for antitrust regulators when reviewing claims of anti-competitive behavior that involve single firm conduct and innovative technologies.

First, "We should apply greater skepticism when the complaint about a dominant firm comes almost exclusively from rivals, not consumers, and where the remedy would deprive consumers of a choice."

Second, "We should increase that skepticism when the complaining parties engage in forum shopping, failing to make their case before the first, most obvious jurisdiction or government body before taking their case elsewhere."

Third, "We should avoid involving the government in the detailed re-engineering of products produced by private firms, under the guise of antitrust policy; we should question any claim that government regulators are more competent than private firms and consumers to choose the ``best´´ design for a product, particularly when the ``best´´ design must evolve rapidly to meet changing consumer demands."