Antitrust 12/17/2020

Government Sues Facebook Under Novel Legal Theory that Success is Bad 

Chris Marchese
Chris Marchese Counsel

Last week, 46 state attorneys general and a divided Federal Trade Commission (FTC)  filed separate lawsuits to break up Facebook. Setting aside the number of state Attorneys General at least some of whom are motivated by politics, it’s telling that only three out of five of the country’s top antitrust watchdogs at the FTC approved of the suit.

The two dissenting FTC Commissioners, Commissioners Phillips and Wilson, likely opposed the suit because it cannot be justified under the consumer welfare standard. At its core, antitrust law focuses on whether or not consumers benefit, something seen in Facebook’s free-to-use, high-quality services that benefit over 190 million Americans. The government knows this. But rather than looking to the merits, these lawsuits are pushing a novel and dangerous legal theory: Succeed too much and you’ll be punished. 

From the Department of Justice’s and the state Attorneys General’s equally flawed lawsuits against Google to the House Judiciary Committee’s call to break up Amazon, Apple, Facebook, and Google, the lawsuits join a small but growing movement to politicize antitrust for social and political goals at the expense of everyday Americans.

Below, we’ve picked some of the government’s many flawed arguments below to give a good sense of why the lawsuits are likely to fail and why they should fail.

The government gets Facebook’s market wrong and thus downplays competition.

The first step in most antitrust cases is to prove that the business is a monopoly. And despite the accusations it faces, Facebook is most certainly not a monopoly.

To be a monopoly, a business should have control of at least 66-75% of the relevant market. (The Supreme Court has never found monopoly power below 75%, but the DOJ and FTC use 66% as a threshold.) But the definition of “relevant market” has been used arbitrarily to reach the government’s preferred ends. If you listen to the government, Facebook’s elevant market is more or less just Facebook and thus in the market of Facebook, Facebook is a monopoly. 

This case shows why market definition is ripe for government abuse. If you’re the FTC, for example, you’d want to define the market as narrowly as possible so that a business’s market share looks as big as possible. 

Take Chick-fil-A. If you wanted to show it has monopoly power, you might define its relevant market as “affordably priced fast-food chicken.” And if you really wanted to target Chick-fil-A, you’d add another qualifier: “affordably priced fast-food chicken that’s open for business Monday through Saturday.” But that second market definition is laughably arbitrary because it excludes Chick-fil-A’s many competitors, including McDonald’s, Wendy’s, Taco Bell, Burger King, and regional giants like Whataburger. 

So too is the government’s market definition of Facebook, which it defines as “personal social networking services.” This definition is gerrymandered to exclude competitors–in Facebook’s case, YouTube, TikTok, Snapchat, and so on–and to inflate market share. But unlike the Chick-fil-A example, that may not be immediately clear.

As even the government acknowledges, Facebook’s business model has two sets of consumers: users and advertisers. At its core, Facebook is a matchmaker—it offers users valuable services for free and increases its number of users, which in turn attracts advertisers who want the most bang for their buck. So Facebook’s value to advertisers grows as the number of users and time spent on its platforms grow. 

Just like how advertisers are willing to shell out more money to run ads during the Super Bowl than on billboards dotting rarely traveled roads, the same is true of Facebook. Advertisers are willing to spend more on its platforms when our attention is there. And because Facebook is a private, for-profit business, it wants to keep our attention so that advertisers stay interested.

Given that there are only 24 hours in a day, Facebook competes against anything that draws our time and attention elsewhere. To be sure, this definition is likely too broad because it means Facebook competes against literally everything else in life. But it’s a useful starting point because now we can apply the government’s own test for competition: If Facebook were to raise prices by 5%, where would its consumers–users and advertisers–go? If they wouldn’t leave Facebook, then Facebook is likely a monopoly because it would mean there are no substitutes to Facebook.

But that’s not the case. Even without a price increase, Facebook faces competition. TikTok, a video-sharing platform introduced in 2018, has seen explosive growth in the United States. Today, more young Americans use TikTok than use Facebook. In fact, Twitter, Pinterest, YouTube, Reddit, and Snapchat are all free platforms that Americans use and that compete for advertisers. 

The government tries to get around this competition in digital markets by claiming that Facebook is so distinct from other platforms that they cannot be substitutes. To be sure, Facebook is different from Twitter, YouTube, Snapchat and all the others. But all those services also have plenty in common, such as the ability to message privately with other users, share media from family photos to political news articles, and to form groups and communities. 

At the end of the day, time spent on YouTube means time not spent on Facebook. And time not spent on Facebook means less advertising revenue for Facebook. 

Even if Facebook is just a social media platform, that doesn’t support the government’s market definition. The government claims that Facebook’s market is narrow–it includes only social media platforms that do what it does. At the same time, the government also claims that Facebook bought Instagram and WhatsApp because they were competitive “existential threats” to Facebook’s market share. Both can’t be true. If a photo-editing and photo-sharing app like Instagram posed an “existential threat” to Facebook, then so too does YouTube and TikTok. Likewise, if WhatsApp, a messaging service, also posed such a threat, then so too must all messaging services like iMessage.

Whether you agree that Facebook’s market is one for user attention and advertisements or not, the government’s definition is subjective and unworkable under its own logic.

Facebook’s purchases of Instagram and WhatsApp benefitted consumers.

Even if we accepted the misguided argument that Facebook is a monopoly, being just a monopoly is not illegal. There must also be some resulting harm to consumers. And because Facebook’s acquisitions of Instagram in 2012 and WhatsApp in 2014 benefitted consumers, the lawsuit is destined to fail even if the court buys the government’s arbitrary market definitions. 

Here are the facts:

Instagram

In early 2012, Facebook began the year with over 800 million users and analysts successfully predicted it would reach a billion by year’s end. With sustained growth in the United States and rapid growth abroad, Facebook had never been so popular. Even so, Facebook knew it had to stay innovative or else it’d go the way of MySpace thanks to aggressive competition from a growing set of new and evolved competitors. Thankfully for us, Facebook knew better than to take its success for granted. 

And like other tech companies, Facebook took note of changing trends in consumer preferences. Chief among those changes was the transition from using desktop computers to using cell phones. With more and more consumers using mobile apps, Facebook began a two-track approach to innovation. It redesigned its main platform to better curate content for users and looked for ways to compete in the mobile apps market. From the beginning, Facebook wanted to integrate its full platform with its mobile offerings so that consumers had access to a seamless and innovative service whether on their computers or phones. 

The integration of photo-editing and photo-sharing services, which were growing increasingly popular, was a priority. So much so that Facebook became the first platform to let consumers upload multiple photos simultaneously. That change, something we all take for granted today, was revolutionary a decade ago.

The same year, Facebook launched Facebook Camera, a mobile app that let users edit and share photos as a complement to Facebook’s other services. But Facebook wasn’t alone. Hundreds of photo-editing and photo-sharing apps sprang up around that time. They included familiar names like Flickr, Instagram and once-familiar VSCO Cam. Even existing apps like Foursquare began integrating photo-sharing services into their platforms. Although most see the value of photo-sharing apps today, few at that time appreciated that they’d be the next big thing. 

Instagram, meanwhile, had only 20 million users—a mere 2.5% of Facebook’s size. But it offered consumers a simple way of uploading photos, applying filters, and sharing the end product. Facebook’s CEO Mark Zuckerberg recognized that the app could also be a good complement to Facebook. And because it had features that supported Facebook Camera’s, it could be integrated with Facebook to deliver the best possible experience to users. Not everyone at Facebook agreed with Zuckerberg. Some employees thought that Instagram’s filters were too amateurish and that the app would fade in popularity. After all, they noted, the app’s core service centered only on photos and slanted toward sharing photos with “followers” rather than “friends.” 

But Zuckerberg had the business acumen to see Instagram’s potential as a complement to Facebook’s offerings, even as he also acknowledged that Instagram could be a future competitor. The lawsuit makes much of internal documents that acknowledged as much, but in doing so, it misses two key points: First, Instagram offered features that were complementary to Facebook’s. And second, there was nothing to suggest Instagram in 2012 would become the Instagram we know today absent Facebook’s substantial investment in the app’s growth and its integration of the app’s features with Facebook’s to create a superior product for users. 

Instagram also had only 13 employees, no revenue streams, and no plans for revenue. The app stayed afloat through investment capital alone. That business model was unsustainable. Instagram repeatedly rebuffed investors’ advice that it find a path to scalable monetization. To be sure, some businesses have gone years without turning a profit. But they have revenue streams to one day turn a profit. Making matters worse, Instagram was showing signs of distress—it was plagued by spam and lacked the resources and plans to effectively combat it. 

Even so, Instagram was valued at $500 million; Facebook paid $1 billion for it. Although the FTC vetted and—unanimously—signed off on the deal, critics today believe that because Facebook seemingly overpaid, it must’ve been desperate to take out a competitor. In reality, Facebook had business insights and expertise that the rest of us, including many in the press at the time, lacked. It saw an opportunity to integrate Facebook and Instagram in a way that is now popular with and beneficial to consumers. 

It’s all too tempting to look at the success of acquired companies today and assume they would’ve gotten there on their own. Without Facebook’s acquisition, however, it’s unclear how Instagram would’ve developed revenue streams to stay in business, let alone to keep innovating and combat its growing integrity and spam problems. Absent Facebook’s investment, it is very likely that consumers and investors, turned off by the spam, would have abandoned the platform in due time. 

Had Instagram failed, consumers would have been harmed. Instead, Instagram succeeded. Under Facebook’s ownership, over 1 billion people enjoy Instagram, it generates roughly $20 billion in revenue, and it developed from being a niche photo-sharing app into a free and widely used app for creating, sharing, and interacting with content that users love. And thanks to Facebook’s investments, it now uses spam blockers and Facebook’s other technology to protect users from harmful content. Instagram also continues to innovate and to increase market competition. Instagram’s latest feature, “Reels,” lets users create, share, and find short video snippets and competes heavily against TikTok and other video-sharing platforms.

 What’s more, Facebook has benefited consumers by helping small businesses reduce their barriers to entry. In fact, Facebook opened the door for consumers to discover and connect with millions of small businesses, allowing them to more easily and efficiently discover products that fit their needs. By using Facebook’s ad-auctioning system, Instagram gives advertisers of all sizes and budgets the power to reach new audiences all over the world. Indeed, Instagram has been a boon to independent business owners and local businesses looking to grow their brands by giving them far more bang for their buck in digital advertising than these businesses could get in broadcast, print, and other advertising markets. 

Not to be forgotten, Facebook’s auction-based advertising model gives small businesses and entrepreneurs the same chance as larger brands to compete. So not only do they pay less, they are more likely to reach their target audiences. In broadening Instagram’s reach, Facebook also broadened opportunities for more Americans to benefit from Instagram. Facebook’s acquisition of Instagram, in other words, spurred competition in other markets by helping connect consumers with lesser-known brands for everything from mattresses to home exercise equipment.

So as Instagram shows, acquisitions often have procompetitive effects. First, the acquisition increased output—to the tune of a billion users. Second, it improved Instagram’s security and user features, and it better connected users to each other and to businesses. And third, given that Instagram had no revenue streams, it very likely could have gone out of business, thereby depriving consumers of the app. 

Success is never guaranteed—in fact, more often than not, acquisitions fail. But because Facebook invested so heavily in improving Instagram and transforming it into the app we love today, Facebook made Instagram economically viable.

WhatsApp

WhatsApp is another case of Facebook benefitting consumers. Consider first that, as even Facebook’s critics describe  WhatsApp as “principally an encoded messaging app” that is popular “largely in markets outside the US” that had “virtually no revenue stream” at the time of acquisition. (But that did not stop Google from offering $10 billion to buy WhatsApp, or Facebook from ultimately paying $19 billion for it.) 

Because Facebook seemingly overpaid for yet another revenue-raising dud, and has yet to successfully monetize it, critics conclude that Facebook must have done so for anticompetitive reasons. Or, as is actually the case, Facebook saw in WhatsApp what it saw in Instagram: potential to make a decent product great. 

Indeed, if Facebook merely wanted to prevent competition, it failed big time. The mobile-messaging market was highly competitive in 2014 and remains so today. 

And despite Facebook’s struggle to monetize WhatsApp, the acquisition still reflects the business’s sound judgment. For starters, WhatsApp serves Facebook’s long-term strategy to develop encrypted services that give Americans and their counterparts across the world, including in countries with far less respect for individual liberty, the power to communicate safely and privately.

Most important, the acquisition benefitted consumers. WhatsApp used to charge fees; Facebook abolished both subscription and use fees. That means its users have access to a valuable encrypted service for free, something that may not be fully appreciated by government agents who are opposed to encryption. And like with Instagram, Facebook improved WhatsApp so much that it grew to 2 billion users.    

Bottom line, Facebook bought two businesses that had solid ideas but that lacked the resources or expertise to execute them. Facebook integrated those ideas in with its own and invested heavily across the board, improving both and offering them for free

The government misconstrues Facebook’s privacy controls and data-sharing practices.

As you can see, those consumer benefits are inconvenient for the government. So in a desperate attempt to show consumer harm, the government claims that Facebook degraded user privacy and was able to do so because it has monopoly power. If it were not for its monopoly power, the lawsuit claims, Facebook would have had stricter privacy protections because users would have turned elsewhere. 

But this argument fails too. First, Facebook has tightened its privacy controls over the last decade. Second, privacy operates on a sliding scale: Some of us want complete privacy but most of us are content with sharing some information. Because privacy is so subjective, it’s hard to objectively say whether a business has degraded or upgraded it. The best method, then, is to let users choose the platform and their own privacy controls, which is what Facebook and its competitors already do.

That analytical limitation aside, Facebook’s actions have benefitted consumers by tying its privacy policies to what most users want. Indeed, 100% privacy would ruin many of the features we turn to Facebook to use. Consider photo-tagging: Under the government’s theory, consumers’ privacy is degraded when Facebook and Instagram let users tag each other in photos. But most users appreciate the service and for those who do not want tagging, they can change their settings. In fact, Facebook allows users to eliminate tags altogether, review tags in advance, “de-tag” themselves, or hide tagged photos from everyone or just some. 

Finally, it’s worth noting that breaking up Facebook would not increase privacy control. Because of Facebook’s size and value to advertisers, it can implement tighter privacy controls without letting advertisers dictate the terms. By contrast, a smaller platform would likely need to cave to advertiser demands for more data and insight. Moreover, Facebook invests billions into improving its platforms, including its data security and privacy controls. It’s not at all clear that smaller businesses, formed from a break up, could maintain that commitment. 

Who does breaking up Facebook help?

The government never answers this question, at least not convincingly. 

Users benefit immensely from Facebook’s services, including Instagram and WhatsApp. The FTC and Attorneys General realize this, which is why they ask the court not only to break up the businesses but also to force Facebook to continue to “support” the divestments afterwards. In other words, the government wants Facebook to sell Instagram and WhatsApp and to maintain material support for both afterwards.

That’s an impossible ask, but it gets to a central point for why these lawsuits are likely to fail. If these businesses were broken up, users would have fragmented services of a lower quality than they are now, and advertisers would reach smaller audiences for comparatively more money. With so many businesses struggling this pandemic, this seems particularly counterproductive.

And if the goal is to increase competition, forcing Facebook to subsidize these platforms after a break-up would do the opposite. Put simply, when one business has to share inputs with another, it removes the incentive for the latter to invest in making inputs that are better than the former’s. And in Facebook’s case, investments diverted elsewhere means less money to invest in innovation for its main platform. The long-term effect, then, is lower-quality services across the board.

Antitrust law is meant to protect consumers. This case threatens them.

Next Post Don't let Donald Trump crush internet free speech