The Supreme Court is winding down for the year and last week put out a much awaited decision in Ohio v. American Express . Some have rung the alarm with this case, but I think caution is worthwhile. In short, the Court’s analysis wasn’t expansive like some have claimed, but incomplete. There are a lot of important details to this case and the guideposts it has provided will likely be fought over in future litigation over platform regulation. To narrow the scope of this post, I am going to focus on the market definition question and the issue of two-sided platforms in light of the developments in the industrial organization (IO) literature in the past two decades.

Just to review, Amex centers on what is known as anti-steering provisions. These provisions limit merchants who take the credit card payment from implying a preference for non-Amex cards; dissuading customers from using Amex cards; persuading customers to use other cards; imposing any special restrictions, conditions, disadvantages, or fees on Amex cards; or promoting other cards more than Amex. Importantly, these provisions never limited merchants from steering customers toward debit cards, checks, or cash.

In October 2010, the Department of Justice (DoJ) and several states sued Amex, Visa, and Mastercard for these contract provisions, and Amex was the only one among the three to take it to court. Initially, the District Court ruled in favor of the DoJ and states, explaining that the credit card platforms should be treated as two separate markets, one for merchants and one for cardholders. In that analysis, the court cleaved off the merchant side and declared the anti-steering provisions as being anticompetitive under Section 1 of the Sherman Act.

On appeal, the Court of Appeals for the Second Circuit reversed that decision because “without evidence of the [anti-steering provisions’] net effect on both merchants and cardholders, the District Court could not have properly concluded that the [provisions] unreasonably restrain trade in violation” of Section 1 of the Sherman Act. The Department of Justice petitioned the Appeals Court to reconsider the case en banc , but that was rejected and then headed to the Supreme Court.

The Supreme Court agreed with this two-sided theory as “credit-card networks are best understood as supplying only one product—the transaction—that is jointly consumed by a cardholder and a merchant.” Even though the DoJ was able to show that the provisions did increase merchant fees, “evidence of a price increase on one side of a two-sided transaction platform cannot, by itself, demonstrate an anticompetitive exercise of market power.” To prove this, the DoJ would have to prove that Amex increased of the cost of credit-card transactions above a competitive level, reduced the number of credit-card transactions, or otherwise stifled competition in the two-sided credit-card market.

The decision only briefly mentions why this is important, so consider a platform with two sides, users and advertisers. If users experience an increase in price or a reduction in quality, then they are likely to exit or use the platform less. Yet, advertisers are on the other side because they can reach users. So in response to the decline in user quality, advertiser demand will drop even if the ad prices stay constant. The result echoes back.  When advertisers drop out, the total amount of content also recedes and user demand falls because the platform is less valuable to them. Demand is tightly integrated between the two side of the platform. Changes in user and advertiser preferences have far outsized effects on the platforms because each side responds to the other. In other words, small changes in price or quality tends to be far more impactful in chasing off both groups from the platforms as compared to one-sided goods. In the economic parlance, these are called demand interdependencies. The demand on one side of the market is interdependent with demand on the other. Research on magazine price changes confirms this theory.   

In the last two decades, economics has been adapting to the insights and the challenges of two-sided markets. In the case of a one-sided business, like a laundromat or a mining company, there is one downstream or upstream consumer, so demand is fairly straightforward. But platforms are more complex since value must be balanced across the different participants in a platform, which leads to demand interdependencies.

In an article cited in the decision, economists David Evans and Richard Schmalensee explained the importance of their integration into competition analysis, “The key point is that it is wrong as a matter of economics to ignore significant demand interdependencies among the multiple platform sides” when defining markets. If they are ignored, then the typical analytical tools will yield incorrect assessments.

While it didn’t employ the language of demand interdependencies, the Court did agree with that general assessment:

To be sure, it is not always necessary to consider both sides of a two-sided platform. A market should be treated as one sided when the impacts of indirect network effects and relative pricing in that market are minor. Newspapers that sell advertisements, for example, arguably operate a two-sided platform because the value of an advertisement increases as more people read the newspaper. But in the newspaper-advertisement market, the indirect networks effects operate in only one direction; newspaper readers are largely indifferent to the amount of advertising that a newspaper contains. Because of these weak indirect network effects, the market for newspaper advertising behaves much like a one-sided market and should be analyzed as such.

Why does this bit matter?

In a piece in the New York Times in April, Law scholar Lina Khan worried that this case would “effectively [shield] big tech platforms from serious antitrust scrutiny.” Law professor Tim Wu followed up with an op-ed just this past week in the Times expressing similar concern,

To reach this strained conclusion, the court deployed some advanced economics that it seemed not to fully understand, nor did it apply the economics in a manner consistent with the goals of the antitrust laws. Justice Stephen Breyer’s dissent mocks the majority’s economic reasoning, as will most economists, including the creators of the “two-sided markets” theory on which the court relied. The court used academic citations in the worst way possible — to take a pass on reality.

Respectfully, I have to disagree with Wu’s assessment and Khan’s worries. Both Google and Facebook more evidently fall into the newspaper category than the payments category under the majority’s opinion. Moreover, the opinion didn’t define what “weak indirect network effects” actually means in practice, so this case doesn’t leave Google and Facebook off the hook by any means.

How the Court reached that conclusion is worth exploring, however.

In contrast to newspapers, credit card payment platforms “cannot make a sale unless both sides of the platform simultaneously agree to use their services,” so, “two-sided transaction platforms exhibit more pronounced indirect network effects and interconnected pricing and demand.” The Court seems to connect two-sidedness with the simultaneity requirement. On this front, Wu is correct. They didn’t seem to fully understand the economic reasoning. It isn’t the simultaneous nature of credit cards that makes them two-sided markets, but their demand interdependencies. Newspapers also have strong demand interdependencies even though they may not feature the simultaneity of credit cards. Yet, the Court was correct in defining the market as a transactional one, where cardholders and merchants are intimately connected.  

That being said, Breyer’s economic reasoning isn’t any sharper than the majority’s:

But while the market includes substitutes, it does not include what economists call complements: goods or services that are used together with the restrained product, but that cannot be substituted for that product. See id., ¶565a, at 429; Eastman Kodak Co. v. Image Technical Services, Inc., 504 U. S. 451, 463 (1992). An example of complements is gasoline and tires. A driver needs both gasoline and tires to drive, but they are not substitutes for each other, and so the sale price of tires does not check the ability of a gasoline firm (say a gasoline monopolist) to raise the price of gasoline above competitive levels. As a treatise on the subject states: “Grouping complementary goods into the same market” is “economic nonsense,” and would “undermin[e] the rationale for the policy against monopolization or collusion in the first place.” 2B Areeda & Hovenkamp ¶565a, at 431.

Here, the relationship between merchant-related card services and shopper-related card services is primarily that of complements, not substitutes. Like gasoline and tires, both must be purchased for either to have value. Merchants upset about a price increase for merchant related services cannot avoid that price increase by becoming cardholders, in the way that, say, a buyer of newspaper advertising can switch to television advertising or direct mail in response to a newspaper’s advertising price increase.

Breyer makes a bit of a mess when it comes to the idea of demand complementarity. It isn’t the case that “both must be purchased for either to have value.” That is perfect complementarity, which is rare. Rather, when the price of gasoline increases, then the demand for tires is likely to decrease as well. However, it doesn’t need to run the other way. When the price of tires decreases, the demand for gasoline doesn’t typically inch up. This kind of asymmetric demand relationship is counter to the kind of relationship on platforms where demand in linked on both sides.

Still, Breyer buries the lede. Attributing a price increase to firms in the tire market might be wrong if demand fluctuations in the adjacent gasoline market partially caused those prices changes. In other words, the reason why complementary demand matters in the first place is to ensure that the court’s analysis is correct. Going back to Evans and Schmalensee, “The key point is that it is wrong as a matter of economics to ignore significant demand interdependencies among the multiple platform sides” when defining markets. You get the assessments wrong.        

To his credit, Breyer does rightly point out the thin definition offered by the majority:

I take from that definition that there are four relevant features of such businesses on the majority’s account: they (1) offer different products or services, (2) to different groups of customers, (3) whom the “platform” connects, (4) in simultaneous transactions.

Having simultaneous transactions isn’t the defining feature of two-sidedness and if the lower courts come to rely on this feature to define platforms, then some assessments of competitive effects are likely to be wrong.

Amex offers up a lot for the antitrust community to consider, but in key ways, the decision is incomplete. Importantly, the Court didn’t address the validity of many new analytical tools that have popped up in the past decade to understand platform market power. Take a quick glance at the papers cited in the majority opinion and you will notice how many of references dates from after 2010 when this case was first brought. In other words, Amex hardly shuts the door for future litigation.     

Seems like every week the tech rumor mills unveil some new smartphone that’s supposedly going to give the iPhone a run for its money. Over the past couple years, dozens of advanced handsets have been released with much fanfare — the LG Voyager, Palm Pre, Blackberry Storm, Samsung Omnia, to name a few — but time and time again, we end up with a device that can’t hold a candle to the iPhone’s amazing browser, massive app store, and sleek multi-touch interface.

But all this could change later this year. A number of handsets are due for release on several major networks over the next few months that run on Android, Google’s open source mobile operating system. Android is currently available on only a single device, the HTC G1. It’s a decent phone, but it lacks the polish of the iPhone and is only available with a contract from T-Mobile, which lags behind Sprint, AT&T, and Verizon in terms of 3G coverage.

I’m especially excited about the Android 2.0-based Motorola “Sholes,” a great-looking phone that’s supposedly due for release in November 2009 from Verizon. If rumors pan out, the Sholes should come with a slide-out keyboard, an extremely high-res display, a 5MP camera, and all-around solid specs. Via Android and Me:

The Motorola Sholes should include:

• OMAP3430 – 600 MHz ARM Cortex A8 + PowerVR SGX 530 GPU + 430MHz C64x+ DSP + ISP (Image Signal Processor)
• Dimensions 60.00 x 115.80 x 13.70 mm
• Weight 169 g
• Battery Li-ion 1400 mAh.
• Standby 450 hours, talk time 420 minutes
• 3.7-inch touch-sensitive display with a resolution of 854×480 pixels, 16 million color depth. Physical screen size is 45.72 mm by 81.34 mm.
• 512MB/256MB ROM/RAM
• microSD / microSDHC expansion slot
• Camera: 5.0 megapixel with autofocus and video recorder
• Connectivity: USB2.0, 3.5mm audio jack, Bluetooth 2.0 + EDR, Wi-Fi
• Supported audio formats: AMR-NB/WB, MP3, PCM / WAV, AAC, AAC +, eAAC +, WMA
• Supported video formats: MPEG-4, H.263, H.264, WMV
• GPS

Policymakers should take note of the coming onslaught of Android phones as a reminder that platform competition is alive and well in the U.S. wireless market — despite the claims of certain activists and academics whose definition of “consumer choice” encompasses only those devices that they deem sufficiently “open.”

Just when you thought the FCC’s investigation of the wireless industry couldn’t get any stranger, TechCrunch reports that the Commission has sent letters to AT&T, Apple, and Google inquiring about Apple’s recent decision to reject the Google Voice app from the iPhone App Store (as Berin discussed yesterday).

It’s been over two years since the original iPhone was launched, but it seems the FCC still doesn’t get it: the iPhone is very clearly a closed platform — a prototypical walled garden — and Apple has the final say on what applications users can install. When you buy an iPhone, you’re not simply buying a piece of hardware, but actually a package deal that includes software, hardware, and a wireless contract. Is this anti-consumer? 26 million consumers don’t think so. The iPhone 3GS, the latest version of the phone, is selling so fast that Apple’s CFO says they can’t make enough to meet demand!

Of course, the iPhone model isn’t for everyone. I, for one, don’t own one because I’m an obsessive tinkerer and prefer a phone that’s as open as possible. But not everyone shares my preferences. As mentioned above, over 26 million iPhones have been sold since June 2007, so openness clearly isn’t make-or-break for a lot of consumers. Who knows, maybe some people actually trust Apple and like the comfort of knowing that every app they can get comes with a seal of approval from Cupertino.

The FCC’s letter to Apple demands an explanation for why Google Voice was rejected. If Apple’s explanation doesn’t satisfy the FCC’s criteria — which, by the way, are entirely unclear — then what? Will the FCC force Apple to accept Google Voice? Say what you will about Apple’s app store track record, but the prospect of federal regulators having the final word on which applications smartphone owners can install hardly seems pro-consumer. The FCC can’t even figure out how to run its own website!

In some ways, the iPhone has perhaps been too successful for its own good. It’s so popular that many consumers seem to no longer view it as just another product but instead as an item to which they are entitled. Thus, bureaucrats and Congresscritters in search of political points are making a big fuss over the fact that the iPhone isn’t everything to everyone. Why can’t it be wide open? Why isn’t in available on every carrier nationwide? Why is it so expensive to purchase without a service contract?

The answers to these questions lie in the rational self-interested decisions made by Apple and AT&T. The iPhone exists not just to make consumers happy (which it’s been exceedingly successful at doing), but also to make money for Apple and AT&T. And what’s wrong with that? Both firms arguably took a big risk on the iPhone, with Apple putting big bucks on the line to develop it and AT&T accepting an unprecedented arrangement with Apple to hand over a sizable chunk of wireless revenues.

Rewarding penalizing Apple and AT&T’s iPhone gamble with stricter regulations may make some iPhone owners happy in the short run, but it will also make phone developers wary about taking iPhone-esque gambles in the future. Why invest hundreds of millions to hopefully concoct the next big device if the price of success is political predation? (See Barbara Esbin and Berin Szoka’s paper, Should the FCC Kill The Goose That Laid The Golden iPhone, for more on this).

As we often say on TLF, if you don’t care for the iPhone’s App Store, get another phone! There are dozens of smartphones out there that compete with the iPhone. The Palm Pre, LG Versa, Samsung Omnia, and HTC G1 are just a few notable examples.

Want a phone that’s wide-open? Try the G1 — its Android OS is open source and even comes in an unlocked flavor that’s designed for developers. If you love Google Voice, then try a Blackberry — unlike the iPhone, Google Voice works great on Blackberries.

The FCC should stop wasting its time on futile attempts to make already-competitive markets even more so.  Instead, the Commission should be focusing on how to free up the airwaves, most of which remain out of reach of innovators because of outdated rules.

How much platform competition is too much competition? For example, what is the optimal number of mobile operating systems or video game consoles that will spur competition and innovation in those respective sectors?

It is an interesting business question, but it also has some policy implications since some might propose laws or regulations to remedy a perceived lack of platform competition in various sectors. After all, many people would answer the above question by saying that there is never such a thing as too much competition. The more platforms the better. But there can be costs associated with too much competition. Let’s consider those two case studies mentioned above: mobile operating systems or video game consoles.

Mobile Operating Systems As my colleague Berin Szoka has pointed out, we are witnessing the rapid proliferation of mobile operating systems, especially on the open source front. So, we’ve got Apple’s iPhone platform, Microsoft’s Windows Mobile, Symbian, Google’s Android, the LiMo platform, and OpenMoko.

One one hand, all this platform competition sounds great. But as Ben Worthen of the Wall Street Journal’s “Business Tech Blog” points out in a piece today:

there’s a new platform war being waged, but this time the battleground is mobile devices. The bad news for businesses looking to standardize on a winner: The most likely outcome is multiple survivors. […] In fact, rather than consolidating, the number of platforms for which developers can write mobile-device software keeps growing, says Benjamin Gray, an analyst at Forrester Research. That’s a challenge for businesses, in part because workers increasingly want to be able to choose the device that they think is the best fit for their life. In the PC world, the answer would be simple: Write software that people access over the Internet through a Web browser, which isn’t dependent on an operating system. But most devices can’t connect to the Internet at the speed necessary to run such software, Mr. Gray says. And besides, screen size varies from device to device, meaning that software that looks good on one might not on another. Add it all together and it means that businesses need to pick and choose their battles. It’s probably wise to let workers who only need to access email or software that runs on multiple mobile platforms use whatever device they choose. But it probably won’t be cost-effective to give the same choice to workers who have to access custom-developed software through their devices — not unless a business wants to spend the time and money developing a version of the software for every platform out there.

This is the other side of the platform competition coin that many people never consider, especially in the policy arena. At some point, increased mobile OS competition is going to impose serious costs on application developers looking to push their innovations our far and wide, and as quickly as possible.

Consider a really exciting new mobile application like Loopt, which I have written about here before. Loopt is a great little mobile app that allows users to instantly geo-locate each other and network in ways unimaginable just a few years ago. Loopt has been working hard to make its service available on as many platforms as possible, but the company has to deal with dozens of handsets and a growing number of OS platforms used by multiple carriers. A friend of mine who works with Loopt was telling me this week how this is really making it difficult for Loopt to push its technology out as far and wide as they would like. With each new handset, carrier, and OS standard, the company faces formidable development costs. Essentially, Loopt needs an in-house development team for each standard.

Thus, it is possible to reach a point of diminishing returns in terms of platform competition. While few would call for an mobile operating system monopoly, a world of dozens of competing standards could hurt product development and diffusion.

Video Game Consoles The same principle applies to video game console competition and its effect on innovation. Some would say that there is already far too much platform competition in this field. Consider the platforms or consoles that game developers must code for just here in the United States: Microsoft Xbox 360 and the older Xbox, Sony PS3 and the old PS2, Sony PlayStation Portable, Nintendo Wii, Nintendo DS, sometimes the Mac, and finally the good old PC platform. Large developers have the scale and resources to develop new games for most of those platforms. (For example, EA’s latest “Madden 08” football game is being developed for all of those platforms. But most developers don’t have the resources to match Electronic Arts and can’t develop for all those platforms.

It is ironic, therefore, that EA has actually been making waves lately by calling for a single gaming platform or standard. Gerhard Florin, a senior executive at EA, told BBC News last year that proliferating platform competition has made life harder for developers and consumers. “We want an open, standard platform which is much easier than having five which are not compatible,” he argued.

So, when even Electronic Arts is saying there’s too much competition in this regard, you know something is up. After all, it would be in their competitive advantage to absorb the costs associated with multi-platform development since smaller competitors can’t match that sort of multi-platform capital outlay.

How steep are those development costs? And what does it mean for both developers and consumers of games? I think Matt Peckman over at PC World has done a pretty good job summarizing the costs:

Just remember, having too many choices can be just as onerous as having none. I don’t know about you, but I play games, not hardware. An open-standard approach to the engine under the hood sounds like it’d give me more choices in terms of software and peripherals long term, not fewer. […] A unified game hardware architecture would make life for software studios dramatically easier. It levels the playing field and simultaneously increases competition by pitting more developers against each other. It says “Everyone has access to the same toolset, so you can stop complaining about how hard X is to code for or worrying about allocating resources to different teams for different platforms, and instead simply focus on making really, really, really mind-bending stuff for one system.”

Of course, there is another side to the story. Video game platform competition has yielded remarkable innovations at the console level. I can think of at least three ways this is true:

(1) The race to constantly increase processing power: Just look at the competition between Microsoft and Sony to produce state of the art graphical capabilities by packing massive processing power into their the new machines. (2) Unique innovations in console peripheral devices: If we only had one gaming console or standard, would we have ever seen Nintendo’s amazing motion sensitive controller for the Wii? (3) The race to develop consoles that are not just gaming devices, but are full-blown integrated entertainment hubs. I use my XBox 360 and Sony PS3 to download all sorts of movie and TV content — especially high-def movies and new movie trailers. I can also use those consoles to ship my media around my house from computer to computer.

But do such benefits outweigh the costs? Would it be the case, as Matt Peckman suggest above, that reallocating resources to single platform development would result in “really, really, really mind-bending stuff for one system”? The problem with that logic is that we already have some really mind-bending stuff being developed for the multiple platforms these days. Think “Gears of War” (exclusive to XBox), “Metal Gear Solid” (exclusive to PS3), and “World of Warcraft” (exclusive to PC). Then again, why should we need to own 3 different platforms to play these 3 wonderfully innovative games?

In sum, there are profound trade-offs at work when we think about platform competition, whether we are talking about video games or mobile operating systems. There is no right answer to the question of how many platforms is too many. Markets decide these things in an evolutionary way over time. I think it is exciting that we are lucky enough to live in a world where intense platform competition is possible and new entrants are free to jump in the game at any time. That being said, I am equally comfortable with the fact that markets might eventually settle for fewer platforms — perhaps even a single standard — at other times. So long as that process is the result of natural market evolution, and not artificial government choices, I am fine with it.