updated 10:58 pm EST, Wed March 5, 2014
Original judge, DOJ misapplied antitrust law, 'ignored economic evidence'
Two economists from CalTech and NYU have filed an amicus curae ("friend of the court") brief that makes powerful arguments for a reversal of the verdict in the original bench trial overseen by Judge Denise Cote. Across more than 30 pages, they tell the appeals court that fundamental concepts of antitrust law and crucial economic evidence and reasoning were "disregarded" by the judge.
Fortune's Philip Elmer-Dewitt points to a three-paragraph summary written by the economists as the "heart" of their arguments to the court, which he says lays out their view "more clearly than perhaps Apple's own trial lawyers" that the original court (and, by extension, the US Department of Justice) deliberately ignored key defences, appeared not to have a good grasp on antitrust law limitations and market dynamics, and that "these errors threaten to chill competition by discouraging the use of common vertical contracting techniques that are often essential to facilitating the expensive and risky investments needed for entry into highly concentrated markets," referring to Amazon's former near-monopoly of the existing e-book market.
Right from the opening, the economists state flat-out that Judge Cote "failed to consider the economics of the vertical agreements between Apple and the Publisher Defendents" in that "efficient markets depend on firms acting in their independent business interests" and that she "never considered evidence and economic reasoning that the vertical agreements were in Apple's independent business interest in entering e-book retailing, wholly apart from any horizontal conspiracy." Legal scholars and various media outlets have argued that the entire case hinged on a fundamental misunderstanding of antitrust law: that "vertical" parties like resellers (in this case, Apple) can't be part of a "horizontal" conspiracy (alleged to have happened among the publishers).
The economists also say that the "provisions of the agreements at issue-agency, 'most-favored-nation' (MFN) clauses, and price caps-can be instrumental in facilitating new entry, particularly into markets with an entrenched, dominant firm." They argue that in this case, the District Court "disregarded economic evidence and reasoning that these provisions served Apple's independent business interest in entering the e-book market, where Amazon was a near-monopolist." At the time of the alleged conspiracy, Amazon (which was selling e-books below its cost in an effort to build its Kindle hardware business) controlled more than 90 percent of the nascent e-book market, which was blocking competitors.
"The District Court also ignored economic evidence and reasoning suggesting that Apple's entry into e-book retailing, and not the MFNs, allowed the Publisher Defendants to persuade Amazon to switch from a wholesale to an agency business model," the authors said, adding that Judge Cote "also erred in equating price increases for some e-books with harm to competition. Apple's entry into the e-book retail market dramatically increased competition by diminishing Amazon's power as a retail monopolist (and its ability to pursue a 'loss-leader' strategy that inefficiently priced e-books below their acquisition cost). That increased competition gave publishers more bargaining power, thereby bringing e-book pricing closer to competitive levels."
The two interpret Apple co-founder Steve Jobs's suggestion of a "normative" price of e-books (a sustainable level where publishers and resellers both profit, allowing the market to diversify as more publishers emerge) -- which the DOJ famously held up as "proof" that Jobs intended to fix prices -- as more of an attempt to ensure a stable market for multiple competitors rather than Amazon's plan to control the market entirely and eventually raise prices on its own to whatever level it wished, unchallenged by normal market forces or competition.
The authors of the brief, Bradford Cornell from CalTech and Janusz Ordover from NYU, say that the original court and DOJ's misunderstandings and errors "threaten to chill competition" by making commonly-used vertical business procedures illegal in other industries, or anywhere where a single company is highly dominant in an emerging market. "Our antitrust laws should encourage, not penalize, vertical contracting arrangements that facilitate entry and enhance competition," they write.
The DOJ is expected to file its position with the Second Circuit Court of Appeals, which is hearing Apple's appeal, in May. There is no word on when the retrial may get underway.