DRAFT
BEHAVIORAL ECONOMICS AND DYNAMIC COMPETITION
Maurice E. Stucke*
INTRODUCTION
Antitrust’s concept of competition assumes rational market
participants with willpower who pursue their self-interest. This Article first
examines how our conception of competition alters when this assumption is
relaxed to reflect bounded rational market participants with imperfect
willpower and bounded self-interest. Part II examines two implications of
this dynamic theory of competition on antitrust’s monopolization law,
namely herding and behavioral learning as entry barriers and second a
monopolist’s exploitation of biases to illegally maintain its monopoly.
I.
THEORY OF COMPETITION WITH BOUNDED RATIONAL FIRMS AND
CONSUMERS
Before addressing the implications of behavioral economics on
antitrust’s monopolization standard, it is helpful to quickly sketch how
behavioral economics can inform our conception of competition.
The
prevailing assumption underlying today’s antitrust policy is that firms,
consumers, and the government are rational. As I discuss elsewhere,1 our
theory of competition changes when one relaxes the assumption of rational
firms, consumers, and government. My aim here is summarize Scenario IV
competition, whereby both firms and consumers are bounded rational.2
*
Associate Professor, University of Tennessee College of Law; Senior Fellow,
American Antitrust Institute. I wish to thank for their helpful comments <insert>. I also
thank the University of Tennessee College of Law for the summer research grant.
1
Maurice E. Stucke, Reconsidering Competition, Mississippi L.J. (forthcoming 2012),
available at http://ssrn.com/abstract=1646151.
2
Id. (discussing competition under scenarios I (firms, consumers, government
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Under Scenario IV competition, biases and heuristics are systemic. At
closer inspection, competition under Scenario IV is better viewed as a
discovery process than a stable equilibrium. Bounded rational firms have
imperfect knowledge about current and future consumer preferences, a
blurred and changing understanding of their goals and preferences, and a
limited repertoire of actions to cope with whatever problems they face.3
Bounded rational consumers have changing and, at times, inconsistent
preferences.4
Thus, under a behavioral lens, competition is more fully understood as
an “evolutionary trial and error process, in which the firms try out different
problem solutions and can learn from the feedback of the market, which of
their specific products and technological solutions are the superior ones.”5
Rather than an end-state capable of being perfected, competition is a
continuous process “in which previously unknown knowledge is
generated,” and “the multiplicity and diversity of the (parallel trials of the)
firms might be crucial for the effectiveness of competition as a discovery
procedure.”6 Firms and consumers make mistakes, readjust, and undertake
new strategies. The competitive process “is inherently a process of trial and
error with no stable end-state considered by the participants in the
rational); II (firms relatively more rational than consumers); III (consumers relatively more
rational than firms; and IV (firms, consumers, and government bounded rational).
3
Giovanni Dosi & Luigi Marengo, On the Evolutionary and Behavioral Theories of
Organizations: A Tentative Roadmap, 18 ORG. SCI. 491, 492, 494 (2007).
4
See, e.g., Steven C. Michael & Tracy Pun Palandjian, Organizational Learning and
New Product Introductions, 21 J. PRODUCT INNOVATION MGMT. 268, 270 (2004)
(discussing shampoo industry dynamism where consumers with changing tastes buyers
seek variety); Richard Layard, Happiness & Public Policy: A Challenge to the Profession,
116 THE ECON. J. C24, C24 (2006) (noting from happiness economic literature how “tastes
are not given – the happiness we get from what we have is largely culturally determined”).
5
Kerber, supra note Error! Bookmark not defined., at 2; see also Moreau, supra
note Error! Bookmark not defined., at 851 (discussing how “evolutionary theory refutes
the neoclassical economic theory’s focus on a steady state of the economic system”).
6
Kerber, supra note Error! Bookmark not defined., at 2.
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Behavioral Economics and Dynamic Competition
3
process.”7
Scenario IV involves several important competitive dimensions beyond
price. One facet of competition is the extent to which bounded rational
firms debias themselves to provide a competitive advantage.8 The corporate
literature describes firms being overconfident about a merger’s likely
efficiencies,9 overvaluing the purchased assets,10 being overly confident or
pessimistic about their chances of entering particular markets, 11 and
consistent with the sunk cost fallacy throwing good money after bad in
corporate projects.12 Even though firms are bounded rational, it does not
follow that their heuristics and biases are of the same nature and to the same
7
Moreau, supra note Error! Bookmark not defined., at 851.
See, e.g., Andrew Healy, Do Firms Have Short Memories?: Evidence from Major
League Baseball, 9 J. SPORTS ECON. 407, 415-18 (2009) (discussing how some
professional baseball teams overweigh, relative to more successful teams, athletes’ recent
performance in determining salary).
9
See, e.g., Matthew T. Billett & Yiming Qian, Are Overconfident CEOs Born or
Made? Evidence of Self Attribution Bias from Frequent Acquirers, 54 MGMT. SCI. 1037
(2008) (finding from sample of public acquisitions between 1985 and 2002 that CEOs who
previously engaged in a successful acquisition appear to overly attribute their role in
successful deals, leading to more deals even though these subsequent deals are value
destructive); ROBERT F. BRUNER, DEALS FROM HELL: M&A LESSONS THAT RISE ABOVE
THE ASHES (2005) (summarizing major failed mergers).
10
Mathew L.A. Hayward & Donald C. Hambrick, Explaining the Premiums Paid for
Large Acquisitions: Evidence of CEO Hubris, 42 ADMIN. SCI. Q. 103 (1997) (finding from
empirical study of mergers over $100 million involving publicly traded firms over four
year period that CEO hubris plays a substantial role in acquisition process and acquisitions
tend to reduce shareholder wealth); see also Mauricio R. Delgado et al., Understanding
Overbidding Using the Neural Circuitry of Reward to Design Economic Auctions,
SCIENCE, Sept. 26, 2008, at 1849; RICHARD H. THALER, WINNER’S CURSE: PARADOXES
AND ANOMALIES OF ECONOMIC LIFE 50–62 (1992) (discussing experimental and field
evidence); Mackintosh, supra note Error! Bookmark not defined., at 15 (discussing a
2010 auction of a $20 bill for $61).
11
Amanda P. Reeves & Maurice E. Stucke, Behavioral Antitrust, 86 INDIANA L.J.
(forthcoming 2011) (discussing increasing interest in behavioral economics and its
applications to competition law), available at http://ssrn.com/abstract=1582720; Maurice
E. Stucke, Behavioral Economists at the Gate: Antitrust in the Twenty-First Century, 38
LOY. U. CHI. L.J. 513 (2007).
12
Malcolm Baker et al., Behavioral Corporate Finance: A Survey 49 (Sept. 29, 2005),
http://ssrn.com/abstract=602902; Hal R. Arkes & Catherine Blumer, The Psychology of
Sunk Cost, 35 ORGANIZATIONAL BEHAVIOR & HUMAN DECISION PROCESSES 124-140
(1985).
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degree.13 Accordingly, firms can implement mechanisms to debias their
outlooks and decision-making. Firms with significant free cash flow can
seek advice from outside advisors to evaluate prospective mergers to ensure
the senior managers are not overconfident or optimistic on the potential
efficiencies.14 As the management consulting firm McKinsey & Company
summarized,
First, managers can become more aware of how biases can
affect their own decision making and then endeavor to counter
those biases. Second, companies can better avoid distortions
and deceptions by reviewing the way they make decisions and
embedding safeguards into their formal decision-making
processes and corporate culture.15
One effective mechanism for firms to identify biases and take
preventive measures is through “frequent, rapid, and unambiguous
feedback.”16 Accordingly, an important competitive dimension is providing
firms (like consumers) the incentive to improve feedback mechanisms and
ultimately their decision-making and willpower.17
With bounded rational firms with imperfect information, a second
13
John A. List, Neoclassical Theory Versus Prospect Theory: Evidence from the
Marketplace, 72 ECONOMETRICA 615, 615 (2004); John A. List, Does Market Experience
Eliminate Market Anomalies?, 118 Q. J. ECON. 41 (2003). For example, frequent and more
experienced sports cards traders display less of an endowment effect for sports cards (such
as baseball trading cards) than for other items such as chocolates and mugs.
14
Ulrike Malmendier, A “New” Paradigm in Corporate Finance: The Role of
Managers and Managerial Biases, 4 NBER REPORTER 13, 15-16 (2010) (discussing
correlation between overconfidence and acquisitions by cash-rich firms not dependent on
external financing).
15
Dan P. Lovallo & Olivier Sibony, Distortions and Deceptions in Strategic
Decisions,
McKinsey
Quarterly,
Feb.
2006,
available
at
http://www.mckinseyquarterly.com/Distortions_and_deceptions_in_strategic_decisions_17
16.
16
Lovallo & Sibony, supra note **; Camerer & Malmendier, supra note Error!
Bookmark not defined., at 269 (noting some of the literature, such as investment firms
combating loss aversion by having traders switch positions with one another).
17
See Linda Argote & Henrich R. Greve, A Behavioral Theory of the Firm – 40 Years
and Counting: Introduction and Impact, 18 ORG. SCI. 337 (2007) (surveying impact of
Behavioral Theory of the Firm’s impact on organizational science research, including
institutional theory and population ecology); Dosi & Marengo, supra note **, at 491.
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Behavioral Economics and Dynamic Competition
5
important dimension of competition is the ways in which companies learn,
accomplish tasks, and deal with the uncertainty, which again can vary
across firms.18 Rather than incur costs to continually process information
anew, bounded rational firms (like consumers) can use rules-of-thumb
(heuristics).
Firms with better routines/rules-of-thumb can lower their
information processing and decision-making costs to gain a competitive
advantage.
While providing at times a competitive advantage, corporate routines
can also disadvantage firms competitively. Bounded rational firms face the
risk of competency traps, whereby they become wedded to existing
routines, which as industry conditions change, place the firms at a
competitive disadvantage.19 One CEO recently observed the paradox: “in a
creative company, you want to give as much variability as possible, and yet
in a manufacturing process you want as little variability as possible.”20
Under Scenario IV, “[i]n some sense knowledge depreciates in value over
time.”21
So another important dimension of competition is adaptive
efficiency,22 whereby bounded rational firms update routines to reflect
consumers’ changing preferences.23 Rational choice theory often views
18
Dan Lovallo & Olivier Sibony, The Case for Behavioral Strategy, MCKINSEY Q. 3
(March 2010) (noting recent survey of 2,207 executives where only 28 percent said the
quality of their companies’ strategic decisions was generally good, 60 percent thought that
bad decisions were about as frequent as good ones, and 12 percent thought good decisions
were altogether infrequent).
19
Eyal Biyalogorsky et al., Stuck in the Past: Why Managers Persist with New
Product Failures, 70 J. MARKETING 108 (2006) (discussing the “extensive attention in the
literature” to firms’ escalation of commitment, which is the tendency of managers to stay
committed to a course of action despite strong negative feedback with respect to the
advisability of this action); Michael & Palandjian, supra note 4, at 270 (discussing
literature on competency traps).
20
Hal Weitzman, The Man who Turns Post-it Notes Into Bank Notes, Fin. Times, Feb.
28, 2011, at 12 (quoting 3M CEO George Buckley).
21
NORTH, UNDERSTANDING, supra note Error! Bookmark not defined., at 23
(discussing uncertainty in a non-ergodic world (e.g., Scenario IV)).
22
Id. at 70.
23
Michael & Palandjian, supra note 4, at 275.
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suspiciously a strong incumbent firm that seeks to acquire a maverick firm
with a new technology or business model.24 But in the business literature, a
firm may acquire a maverick with a disruptive business model or
technology to better adapt and compete.25
A third important dimension of Scenario IV competition is the
importance of scale, openness, randomness, and connectivity. Innovation,
as Steven Johnson recently wrote, occurs mostly in the adjacent possible,
namely iterative advances leading from one innovation to an improvement
in the adjoining space:
“Environments that block or limit those new
combinations–by punishing experimentation, by obscuring certain branches
of possibility, by making the current state so satisfying that no one bothers
to explore the edges—will, on average, generate and circulate fewer
innovations than environments that encourage exploration.”26 Networks,
and as discussed below network effects, are playing a greater role across
industries. Firms can learn and adapt more quickly through the Internet’s
social network technologies. Firms are also developing internal networks to
better interact with employees and disperse information and ideas. Some
firms are fully networked, combining both external and internal networks.
One recent survey of 3,249 executives found significant correlations
between market share gains and companies that are fully networked.27
Indeed with the proliferation of data on consumer preferences and
purchasing behavior, networks will increase in competitive significance.
By increasing the collaboration among consumers, suppliers and firm
employees, the firms can quickly gain insights of the adjacent possible
24
2010 Horizontal Merger Guidelines § 2.1.5.
Clayton M. Christensen et al., The New M&A Playbook, Harv. Bus. Rev., March
2011, at 49, 50, 54-55.
26
STEVEN JOHNSON, WHERE GOOD IDEAS COME FROM: THE NATURAL HISTORY OF
INNOVATION 36, 41 (2010).
27
Jacques Bughin & Michael Chui, How Web 2.0 Pays Off: The Growth Dividend
Enjoyed by Networked Enterprises, 2 McKinsey Quarterly 17, (2011)
25
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(modifications to an existing technology or collection of technologies) and
better tailor products and services to accommodate changing consumer
preferences.
A fourth dimension of Scenario IV competition is the value of
individuality, creativity, and ethics.
Under antitrust’s rational choice
theory, firms and consumers are undifferentiated in motivation. They seek,
whenever the opportunity, to promote their economic self-interest.
But profit-maximization, as a direct goal, is arguably self-defeating for
firms and consumers. “The most profitable businesses” observed John Kay
“are not the most profit oriented.”28 Companies with excellent reputations
deliver more than profits for their shareholders; they deliver value to
society.29 Moreover, firms, even monopolists, at times do not behave as
their rational self-interested counterparts in exploiting consumers.30 One
28
JOHN KAY, OBLIQUITY: WHY OUR GOALS ARE BEST ACHIEVED INDIRECTLY 12, 2434 (2011).
29
2011 Harris Annual RQ Poll, supra note **, at 9 (companies with high reputation
quotients can be characterized as “’support[ing] the infrastructure of the lives of the
American public, both personally and professionally”); Michael Porter, Shared Value,
Harvard Bus. Rev. **
30
Concurring Statement of Comm’r J. Thomas Rosch, FTC v. Ovation Pharms., Inc.
(Dec.
16,
2008),
available
at
http://www.ftc.gov/os/caselist/0810156/081216ovationroschstmt.pdf (hereinafter “Rosch
Concurrence”); Concurring Statement of Comm’r Jon Leibowitz, FTC v. Ovation Pharms.,
Inc.
(Dec.
16,
2008),
available
at
http://www.ftc.gov/os/caselist/0810156/081216ovationleibowitzstmt.pdf
(“Leibowitz
Concurrence”). Ovation Pharmaceuticals, Inc. acquired two drugs to treat patent ductus
arteriosus (“PDA”), a serious congenital heart defect in newborns. First, Ovation acquired
from Merck the drug Indocin. Several months later, Ovation acquired from Abbott
Laboratories the U.S. rights to the drug NeoProfen. After acquiring NeoProfen, Ovation
raised the price it charged hospitals for Indocin by nearly 1,300 percent. In December
2008, the FTC challenged under Section 7 of the Clayton Act Ovation’s acquisition of
NeoProfen as a merger to monopoly in a market for drugs used to treat PDA. Although
Commissioner Rosch voted in favor of the Section 7 challenge, he argued in his
concurrence that Ovation’s earlier acquisition of Indocin was also subject to challenge
under Section 7. Here the actual evidence is hard to reconcile with the Chicago School’s
neoclassical economic theories. Specifically Indocin for many years was the only FDAapproved pharmaceutical treatment for PDA. Given Indocin’s market position, Merck (its
original owner) could have charged a monopoly price for its drug. Indeed under the
Court’s dicta in Trinko, Merck’s charging a monopoly price would serve “an important
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key driver of corporate reputation is whether consumers perceive that
company having high ethical standards.31
Labor, under rational choice theory, is a commodity, an instrument for
providing goods and services, which can be downsized, outsourced, or
automated.32 There is no inherent dignity in work or greater social calling
to use one’s skills to society’s betterment. But as a matter of common
experience, the greater value we see our work as having, the more meaning
we can attribute to our labor, the more engaged and motivated we are in our
work.33
Scenario IV’s theory of competition helps explain why firms
devote significant resources in identifying and attracting talented workers.
It re-introduces moral beliefs of why we work.34 Scenario IV competition
enriches our definition of labor, namely the opportunity to use one’s unique
gifts to improve the welfare of others, and thereby express and deepen
individual dignity. In addition, by inculcating a unique identity, firms can
element of the free market system,” in that monopoly pricing serves as an inducement to
“attract[] ‘business acumen’ in the first place” and engage in “risk taking that produces
innovation and economic growth.” Trinko, 540 U.S. at 407. In a world of rational profitmaximizers, consumers would applaud, not condemn, Merck. Charging parents whose
babies were born with this potentially life-threatening congenital heart defect the monopoly
price would signal others to invest in such innovative drugs. Instead, reality suggests that
consumers and rational choice theorists differ at times in their perception of what is fair.
31
Harris Interactive, The 2011 Harris Interactive Annual RQ Summary Report 7 (Apr.
2011) (interviewing 30,104 people on the reputations of 60 highly visible companies). Not
surprisingly among the 60 companies with the poorer reputations was cable company
Comcast, two domestic airlines (American and Delta), five financial institutions (JP
Morgan Chase, Bank of America, Citigroup, Goldman Sachs, and AIG), two domestic
automobile and two oil companies responsible for monumental oil spills (BP, ExxonMobil)
32
In contrast the Clayton Act provides that the “labor of a human being is not a
commodity or article of commerce.” 15 U.S.C. § 17 (2006).
33
DAN ARIELY, THE UPSIDE OF RATIONALITY: THE UNEXPECTED BENEFITS OF
DEFYING LOGIC AT WORK AND HOME 66-82 (2010); Jason Krieger, Creating a Culture of
Innovation,
GALLUP
MGMT.
J.,
Oct.
5,
2010,
http://gmj.gallup.com/content/143282/creating-culture-innovation.aspx (finding that higher
levels of employee engagement “correlate to more idea sharing, better idea generation,
more creativity in role, and improved business outcomes (on key items, including customer
metrics, productivity, and profitability)”).
34
R.H. TAWNEY, THE ACQUISITIVE SOCIETY 33 (2004) (“For what gives meaning to
economic activity, as to any other activity is [] the purpose to which it is directed.”)
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promote (or hinder) social, ethical and moral values that affect employee
behavior;35 these values in turn can lower the firm’s monitoring costs and
increase its competitiveness.36
Scenario IV competition, while offering several additional competitive
dimensions, also presents two additional risks.
One risk is that with
bounded rational firms and consumers, some forms of market failure (such
as cartels and monopolies) are likelier than rational choice theory predicts.37
The stronger the presumption of rationality, the more likely the market will
be efficient, the less the governmental concern over the sustained exercise
of market power in markets characterized with low to moderate entry
barriers. Rational consumers often can defeat the exercise of market power
by switching to lower-cost substitutes offered by rational fringe firms or
entrants.
But as discussed below, bounded rational consumers do not
switch as predictably as rational choice theory predicts.38 Bounded rational
firms will not always enter.39 Cartels can be more durable when pricefixers, like the subjects in other behavioral experiments, are more trustful
35
Paul C. Nystrom, Differences in Moral Values between Corporations, 9 J. BUS.
ETHICS 971, 974 (1990) (survey of how closely-matched corporations within industrial
sectors differed significantly in perceived importance of management’s moral values).
36
GEORGE A. AKERLOF & RACHEL E. KRANTON, IDENTITY ECONOMICS: HOW OUR
IDENTITIES SHAPE OUR WORK, WAGES, AND WELLBEING 39–59 (2010) (exploring how
workers can abide to shared corporate norms, and lose utility when they put in low effort,
and how job-holders, if they have only monetary rewards and only economic goals, “will
game the system insofar as they can get away with it”).
37
Stucke, Behavioral Economists, supra note 11, at 546-75. At times, market failure
is less likely than rational actors faced with the prisoner dilemma. Some people are more
trusting than others, and willing to incur a cost to punish unfair behavior. With a sufficient
number of these conditional cooperators in the group, one study of 49 forest group users,
the tragedy of the commons can be averted. Devesh Rustagi et al., Conditional
Cooperation and Costly Monitoring Explain Success in Forest Commons Management,
Science, Nov. 12, 2010, at 961.
38
See infra ; see also U.K. Independent Commission on Banking, Interim Report
Consultation on Reform Options 33-38 (Apr. 2011) (noting how consumers do not switch
banks as often as economic theory predicts).
39
Reeves & Stucke, Behavioral Antitrust, supra note 11.
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and cooperative than rational choice theory predicts.40
A second risk of Scenario IV competition is new forms of market
failure. In competitive markets, firms identify and discover ways to solve
consumers’ problems.41 But the financial crisis, Professor Stiglitz wrote,
showed how the financial innovations involving the subprime mortgage
industry worsened, rather than solved, borrowers’ problems.42
Their
mortgages increased costs and risks for consumers while providing the
mortgage brokers and lenders greater fees. These products increased risk to
the institutions that acquired the ensuing credit default swaps and
collateralized debt obligations.43 Among the losers in the financial crisis
were other supposedly sophisticated investors who failed to appreciate these
assets’ risks.44
Moreover, these financial innovations made speculation
easer.45 Thus market forces under Scenario IV do not necessarily yield the
desired outcome.
II.
IMPLICATIONS OF DYNAMIC THEORY OF COMPETITION ON
MONOPOLIZATION LAW
Once the assumption of rationality is relaxed, a more dynamic
conception of competition emerges. This conception of competition has
many potential implications for monopolization claims.
This Article
focuses on two implications: entry barriers and behavioral exploitation.
A.
Herding and Behavioral Learning as Entry Barriers
For Robert Bork and others, monopolies (other than those protected by
40
Stucke, Behavioral Economists, supra note 11; Stucke, Am I a Price-Fixer, supra
note Error! Bookmark not defined..
41
Kerber, supra note Error! Bookmark not defined., at 4.
42
STIGLITZ, supra note Error! Bookmark not defined., at 5, 80.
43
MICHAEL LEWIS, THE BIG SHORT: INSIDE THE DOOMSDAY MACHINE (2010).
44
JOHNSON & KWAK, supra note Error! Bookmark not defined., at 199; CASSIDY,
supra note Error! Bookmark not defined., at 272.
45
CASSIDY, supra note Error! Bookmark not defined., at 239, 243-50; GILLIAN
TETT, FOOL’S GOLD: HOW THE BOLD DREAM OF A SMALL TRIBE AT J.P. MORGAN WAS
CORRUPTED BY WALL STREET GREED AND UNLEASHED A CATASTROPHE (2009).
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the government) are short-term phenomena46: the innovator’s supracompetitive profits serve as bait for imitators, who “first reduce and then
annihilate [the monopolist’s] profit,” which reverts to the competitive
mean.47 Innovation attracts imitation, which leads to commoditization.
While not necessarily adopting Bork’s view of entry barriers, U.S.
courts in considering whether a firm can attempt to monopolize, or
monopolize, a market examine the likelihood of entry.48 Entry analysis
plays a key role in any section 2 case. Courts will dismiss a monopolization
or attempted monopolization claim if the plaintiff cannot prove that entry
barriers in the relevant market are “significant” and “substantial” enough to
confer monopoly power.49 Notwithstanding the firm’s intent to monopolize
a market and its anticompetitive conduct, the court could find that rational
profit-maximizing entrants will materialize and rescue the consumer.
Given the importance of entry analysis in monopolization cases, it
follows that the types of entry barriers that the courts recognize are of great
importance. Traditional entry analysis focused on manufacturing,
distribution and regulatory barriers, such as “planning, design, and
management; permitting, licensing, or other approvals; construction,
debugging, and operation of production facilities; and promotion (including
46
ROBERT H. BORK, THE ANTITRUST PARADOX: A POLICY AT WAR WITH ITSELF 19596 (1978).
47
JOSEPH A. SCHUMPETER, THE THEORY OF ECONOMIC DEVELOPMENT 89 (1934).
48
See, e.g., AD/SAT v. AP, 181 F.3d 216, 229 (2d Cir. 1999) (affirming summary
judgment for defendant on attempted monopolization claim and noting that the presence of
“low barriers to market entry” suggested that the defendant would “face significant
competition from new entrants”); Bailey v. Allgas, Inc., 284 F.3d 1237 (11th Cir. 2002)
(affirming summary judgment for defendant in Robinson Patman Act case where plaintiff
failed to show the presence of entry barriers and noting that “the ease or difficulty of entry”
is “[t]he most significant structural factor bearing on the ability to recoup predatory losses
through inflated prices” because “[w]here a market has low barriers to entry, sellers
charging supracompetitive prices will soon attract new competitors, sellers charging
supracompetitive prices will soon attract new competitors”).
49
United States v. Microsoft Corp., 253 F.3d 34, 81, 82 (D.C. Cir. 2001) (“firm cannot
possess monopoly power in a market unless that market is also protected by significant
barriers to entry”).
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[8-FEB-16
necessary introductory discounts), marketing, distribution, and satisfaction
of customer testing and qualification requirements.”50 The agencies’ and
courts’ analyses of entry barriers have evolved.
One important entry
consideration for branded differentiated consumer goods is the time,
expense, and likelihood of an entrant in gaining consumers’ confidence and
trust (especially for products with powerful chemicals that may pose
significant health risks, like hair relaxers).51
Another important development in entry analysis is network effects.52
In Microsoft, the antitrust plaintiff had to prove that (1) “network effects
were a necessary or even probable, rather than merely possible,
consequence of high market share in the browser market and (2) that a
barrier to entry resulting from network effects would be ‘significant’
enough to confer monopoly power.”53 Network effects can be direct or
indirect.54
Direct network effects arise when a consumer’s utility from a
product (e.g., telephone) increases when others use the product.55 Indirect
network effects arise when “the greater the number of users of a given
software platform, the more there will be invested in developing products
compatible with that platform, which, in turn reinforces the popularity of
that platform with users.”56
50
Firms compete to dominate markets
2010 Horizontal Merger Guidelines § 9.
U.S. Dep’t of Justice & Fed. Trade Comm’n, Commentary on the Horizontal Merger
Guidelines 39 (Mar. 2006).
52
See, e.g., Skydive Arizona, Inc. v. Quattrocchi, 2009 WL 2515616, at *2 (D. Ariz.
Aug. 13, 2009) (finding under Daubert that general economic principles on networks and
network effects was reliable foundation); Bristol Technology, Inc. v. Microsoft Corp., 42 F.
Supp. 2d 153, 169 (D. Conn. 1998); U.S. v. Microsoft Corp., 1998 WL 614485, at *4
(D.D.C. Sept. 14, 1998).
53
United States v. Microsoft Corp., 253 F.3d 34, 83 (D.C. Cir. 2001).
54
Marina Lao, Networks, Access, and “Essential Facilities”: From Terminal Railroad
to Microsoft, 62 SMU L. REV. 557, 560-61 (2009).
55
Microsoft, 253 F.3d at 49; In re Ebay Seller Antitrust Litig., 2010 WL 760433, at
*10 (N.D. Cal. Mar. 4, 2010) (eBay not contesting significant entry barriers to the online
auctions market because of network effects).
56
CFI Microsoft ¶ 1061.
51
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13
characterized with network effects, and “once dominance is achieved,
threats come largely from outside the dominated market, because the degree
of dominance of such a market tends to become so extreme.”57
A behavioral economics perspective raises two additional entry
barriers: herding and behavioral learning.
Consumers, at times, are
confronted with competing, incompatible technologies. In choosing, the
consumer wants the technology platform that others will likely choose, as
the more popular platform (e.g., Blu-ray v. HD DVD, Google’s Android
versus Apple58) will attract more supporting complements developed for
that platform.59 Each consumer may prefer the superior technology, but
forego it for the perceived popular one.60 In believing that others will opt
for the subpar technology, the consumer will choose the subpar technology
and contribute to the suboptimal outcome.
Herding leads to irrational
exuberance (or pessimism) over stocks, real estate, and tulips.61
Fads
emerge where a consumer’s utility from an item (such as a designer bag)
depends on who else owns the item (either the perceived trend-setters62 or
masses63). Thus, a firm may seek to secure (or maintain) its monopoly
through herding, by using deceptive statements64 and vaporware.65
57
Novell, Inc. v. Microsoft Corp., 505 F.3d 302, 308 (4 th Cir. 2007).
Dylan Byers, Google and Apple Battle for Developers' Hearts and Minds, at Google
I/O Conference, Fight between Android, iPhone Rages On, Adweek, May 12, 2011,
http://www.adweek.com/news/technology/google-and-apple-battle-developers-hearts-andminds-131550.
59
See United States v. Microsoft Corp., 84 F. Supp. 2d 9, 20 (D.D.C. 1999); Case T201/04, Microsoft Corp. v. Comm’n, 2007 E.C.R. II-3601 (Ct. First Instance).
60
CASSIDY, supra note Error! Bookmark not defined., at 130-31.
61
JOHN KENNETH GALBRAITH, A SHORT HISTORY OF FINANCIAL EUPHORIA (1993).
62
See, e.g., THORSTEIN VEBLEN, THE THEORY OF THE LEISURE CLASS 25, 33 (Penguin
1994) (discussing primary motive to accumulate wealth is pecuniary emulation).
63
Peter Sheridan Dodds & Duncan J. Watts, Influentials, Networks, and Public
Opinion Formation, 34 J. CONSUMER RES. 441-458 (2007).
64
FTC Intel Compl. ¶ 10 (alleging how Intel engaged in deceptive acts and practices to
mislead consumers and the public, including pressuring independent software vendors to
label their products as compatible with Intel and not to similarly label with competitor’s
products’ names or logos, even though these competitor microprocessor products were
58
14
Behavioral Economics and Dynamic Competition
[8-FEB-16
A second entry barrier is behavioral learning, whereby a firm to
effectively compete must attain a sufficient scale of trial-and-error
feedback.
As Part I discusses, bounded rational firms compete by
improving their products and services through a trial-and-error process.
Through trial-and-error firms can increase internal productive efficiencies.
Semiconductor firms, as F.M. Scherer discusses, make mistakes in the early
stages of production, adjust their processes, and thereby lower their
manufacturing costs for their next batch.66
Consequently, aside from the
direct and indirect network effects,67 Intel benefited from another network
effect, namely continually learning from its mistakes during its early
production period, which enabled it to lower costs as it increased output.
Aside from internal behavioral learning, firms can also learn through
their networks with suppliers and customers. Here scale is also critical
when consumer preferences are not stable and predictable. To keep abreast
with changing customer preferences, bounded rational firms rely on trialand-error feedback loops.
Firms experiment with an option, monitor
customer reaction to their (and their competitors’) offerings, readjust, and
monitor. The more feedback firms receive from a larger percentage of
targeted consumers, the more the firms can refine their technologies, the
better able they can match their technology to customers’ preferences, the
greater their competitive advantage. Thus, competitors in some industries
compatible).
65
Maurice E. Stucke, How Do (and Should) Competition Authorities Treat a
Dominant Firm’s Deception?, 63 SMU L. REV. 1069 (2010).
66
Scherer, High Tech, supra note **, at 49-50.
67
Complaint, In re: Intel Corporation, FTC Docket No. 9288, ¶ 10 (discussing the
need simultaneously to secure a large number of users in order to make the product
attractive to software developers and to secure the efforts of software developers in order to
make the product attractive to users, and Intel’s success “in obtaining commitments from
many computer manufacturers and software vendors to build computers and write software
for Intel's new 64-bit Merced microprocessor, even though the product will not be available
for nearly two years”).
8-Feb-16]
Behavioral Economics and Dynamic Competition
15
may require a minimum scale of feedback from bounded rational customers,
without which they cannot effectively compete. One example is search
engines.
To navigate the Internet, Google, Yahoo and other search engines rely
on algorithms to identify web pages that match the consumers’ search
terms.
In this two-sided market, the better the search engine is in
identifying the right matches, the more popular the search engine is for
consumers, the more attractive the search engine is to advertisers seeking to
target those consumers, the greater the advertising revenue the search
engine garners compared to competitors, and the likelier the search engine
company can monopolize this two-sided market.68
Under rational choice theory, an antitrust plaintiff would have a
difficult time proving that (1) network effects were probable and (2) if even
if probable, they would create entry barriers significant enough to confer
monopoly power. With Mozilla’s Firefox Internet browser for example,
one can easily run a search among the different search engines and compare
results.
To the extent one search engine is lagging, it can hire a
competitor’s search engine engineers to develop better algorithms.
Accordingly, one would expect a competitive equilibrium among search
engines, whereby a consumer could obtain roughly similar results for the
same search terms. Absent another point of differentiation (such as better
graphics or quicker results) or a tipping point (similar to daily newspapers
whereby advertisers would support only one competitor), one search engine
should not dominate the market.
But with bounded rational consumers, a new form of network effects
emerges. When a consumer types “orange” and “apple” in Google, for
68
See Competitive Impact Statement, United States v. Google, (D.D.C. Apr. 8, 2011);
Author’s Guild v. Google, No. 05 Civ. 8136 (DC), 2011 WL 986049, at *12 (S.D.N.Y.
Mar. 22, 2011) (recognizing “Google’s market power in the online search market”).
16
Behavioral Economics and Dynamic Competition
[8-FEB-16
example, the search engine quickly generates results that seek to best match
the consumer’s interest. Google has the benefit of observing which, if any,
links the consumer actually chooses. If many consumers choose a link that
was originally offered down the list (say on the fourth page of results),
Google can move that result up the list, and demote suggested links that are
infrequently tapped down the list.
Thus the greater the number of
consumers who use the search engine and the greater the number of
searches, the more trials the search engine company has in predicting
consumer preferences, the more feedback the search engine receives of any
errors, and the quicker the search engine can respond with recalibrating its
offerings.
Increased traffic volumes make more experiments possible,
thereby improving search results.69 With a greater churn of trial and error,
the search engine can quickly adapt to changing preferences, improve its
product, and thereby attract additional consumers to that search engine
compared to competitor sites. If consumers lack time or inclination to run
their search on multiple sites, then entry becomes more difficult. The new
entrant can hire Google’s tech talent, but it still lacks the scale of this trialand-error experimentation. With fewer trials, search results will likely be
inferior going forward in identifying sites that consumers prefer, decreasing
the popularity of that search engine for consumers and advertisers. Indeed,
with more trial-and-error experimentation, the search engine can innovate
with predictive search technology (such as suggesting search phrases that
refine the consumer’s search or her need to complete typing the search
term).
To the extent that preferences diverge across demographics, a search
engine that loses important segment of the population can become a niche
player. As Microsoft observed,
69
Teresa Vecchi et al., The Microsoft/Yahoo! Search Business Case, European
Commission Competition Policy Newsletter Issue 2, at 46 (2010).
8-Feb-16]
Behavioral Economics and Dynamic Competition
17
there's this kind of inverse power loss, where 39 percent of the users
account for 66 percent of all the searches. I think of them as the heavy
searchers. Ourselves and Yahoo! and others have been losing heavy
searchers for the last number of years. Since the Bing launch, we've
actually inverted that, we're actually growing heavy searchers. And
when you look at the demographics, we are over-indexed on 18 to 24
year olds now as a result of those heavy users. Before that, we were
over-indexed on 65-year plus in terms of demographics, which is our
MSN base.70
A justification of the Microsoft-Yahoo partnership was to achieve this
scale of behavioral learning through trial-and-error. In December 2009,
Microsoft partnered with Yahoo! to provide the exclusive algorithmic and
paid search platform for Yahoo! Web sites. Microsoft believed this
agreement would allow it over time to improve the effectiveness and
increase the value of its “search offering through greater scale in search
queries and an expanded and more competitive search and advertising
marketplace.”71 Before the partnership, fewer people used Microsoft’s and
Yahoo’s search engines.72 The European Commission found that Yahoo
and Microsoft were below 10 percent in both search and search advertising
in the European Economic Area.73
Google’s share of the search and
advertising markets was over 90 percent.74
The search business, the
European Commission found, required “substantial and continuous
investment in the quality of the search and related R&D.”75 The
70
Credit Suisse Annual Technology Conference, December 1, 2009, Yusuf Mehdi,
senior vice president, Online Audience Business.
71
Microsoft 2010 Annual Report.
72
Teresa Vecchi et al., The Microsoft/Yahoo! Search Business Case, European
Commission Competition Policy Newsletter Issue 2, at 46 (2010).
73
Vecchi et al., supra note **, at 46.
74
Vecchi et al., supra note **, at 46.
75
Vecchi et al., supra note **, at 46.
18
Behavioral Economics and Dynamic Competition
[8-FEB-16
Commission’s market investigation found that the “quality and relevance of
the algorithmic search engine” as “the most important factor in attracting
users to a particular search engine.”76 As Microsoft’s CEO Steve Ballmer
said,
it turns out there's a feedback loop in the search business,
where the most searches you serve, or paid ad searches you
serve, the more you learn about what people click on, what's
relevant, and it turns out that scale drives knowledge which
then can turn around and redrive innovation and relevance. So,
actually even our ability to understand our customers and
innovate around that is enhanced by putting the two assets
together. It's not just putting them together, but putting them
together in this business, which is unlike other businesses, there
is a return to scale from seeing that much more Internet activity
than either Yahoo! or Microsoft sees independently.77
One year later, Microsoft’s Bing has seen an increase in consumer usage;
whether the search engine will attain the necessary scale to threaten
Google’s monopoly is less clear.78
Consequently, aside from conventional network effects, courts going
forward must consider other entry barriers when consumer preferences are
unstable and hard to predict. To effectively compete, an entrant in some
industries must attract enough consumers (or those heavy consumers whose
preferences most closely resemble the target audience) to engage in this
trial-and-error feedback loop.
This behavioral entry barrier will be of
greater significance going forward as companies seek to match offerings
with consumer tastes. To the extent pairing specific products with consumer
preference is an important facet of competition, companies with more
76
Vecchi et al., supra note **, at 46.
http://www.microsoft.com/presspass/exec/steve/2009/07-29search.mspx.
78
Matt Rosoff, Microsoft Should Have Let Google Have Search To Itself, Business
Insider, Apr. 20, 2011, http://www.businessinsider.com/microsoft-should-have-let-googlehave-search-to-itself-2011-4#ixzz1Lyx0ikow.
77
8-Feb-16]
Behavioral Economics and Dynamic Competition
19
subscribers (like Netflix, Amazon, or Apple’s iTunes) have more
opportunities to predict what movies, books, or music the subscribers would
enjoy, monitor actual selections, and revise their predictions, thereby
adapting to evolving consumer preferences and products. With this scale
from behavioral learning, the company will secure a significant competitive
advantage over smaller rivals and decrease the likelihood that an entrant can
threaten its monopoly.
B.
Behavioral Exploitation
Although firms and consumer, while bounded rational, are not
necessarily bounded rational in the same way and to the same degree.
Firms, for example, may be more susceptible than consumers to one bias in
one factual context (e.g., overconfidence over a merger’s efficiencies).
Moreover being bounded rational with bounded willpower does not
necessarily mean ignorance.
One may recognize one’s shortcomings
(eating snacks before the television rather than exercising), but lack the
necessary commitment device.
Thus firms can compete in ways to help consumers address or mitigate
their biases and bounded willpower and provide consumers a better mix of
solutions.79
As subpart A discusses, bounded rational firms through their
(or monitoring their competitors’) trial-and-error experiments can update
product offerings to accommodate consumers’ changing preferences. Their
ability depends in part on the feedback loop’s efficacy and the competitive
behavior’s transparency.80
Alternatively firms can compete in devising better ways to exploit
consumers’ bounded rationality to the consumers’ detriment. Firms also
79
Kerber, supra note Error! Bookmark not defined., at 4; MISES, supra note Error!
Bookmark not defined., at 24 (“competition among the various entrepreneurs is
essentially a competition among the various possibilities open to individuals to remove as
far as possible their state of uneasiness by the acquisition of consumers’ goods”).
80
Kerber, supra note Error! Bookmark not defined., at 5.
20
Behavioral Economics and Dynamic Competition
[8-FEB-16
can seek to lessen competition by reducing price transparency and
differentiating their products or services through branding and technological
innovation.81
So too monopolists can use the biases and heuristics discussed in the
behavioral economics literature (such as status quo bias, framing effects) to
attain or maintain their monopoly. Through the lens of neoclassical
economic theory, such behavior, rather than exploitive, would appear
benign.
One example is the European Commission’s prosecution of
Microsoft for abusive tying. Although similar behavior was at issue in the
U.S. prosecution, the Commission’s case provides a richer narrative: how
Microsoft premised its defense on rational choice theory; the Commission
and Court of First Instance’s response, which was in accord with behavioral
economics findings of actual consumer behavior; the shortcomings of the
Commission’s remedy (which indeed was predictable under behavioral
economics); the Commission’s reappraisal of its behavioral remedy in the
Internet
browser
settlement,
and
the
remedy’s
advantages
and
shortcomings.
The Commission accused Microsoft inter alia of tying its media player
to its operating system, where it enjoyed a dominant position.
Media
players, which are now ubiquitous, enable consumers to store and play
music and videos on their computers (and now on handheld devices).
Originally RealNetworks licensed Microsoft its media player, RealPlayer.82
In 1997, senior Microsoft executives “noted the dangers of Apple’s and
RealNetworks’ multimedia playback technologies, which ran on several
81
State of Ill., ex rel. Burris v. Panhandle Eastern Pipe Line Co., 935 F.2d 1469, 1481
(7th Cir. 1991) (“Virtually all business behavior is designed to enable firms to raise their
prices above the level that would exist in a perfectly competitive market.”); see also Desai
& Waller, supra note Error! Bookmark not defined.; Steiner, supra note Error!
Bookmark not defined., at 84-85 (discussing price premium for strong reputation brands).
82
CFI Microsoft ¶ 837 (noting how Microsoft included RealPlayer in its Internet
Explorer 4.0).
8-Feb-16]
Behavioral Economics and Dynamic Competition
21
platforms (including the Mac OS and Windows) and similarly exposed
APIs to content developers. Microsoft feared all of these technologies
because they facilitated the development of user-oriented software that
would be indifferent to the identity of the underlying operating system.”83
In 1998, Microsoft released its Windows Media Player, which at that time
supported
different
formats,
including
Apple’s
QuickTime
and
RealNetworks’s RealAudio and RealVideo. But that changed by 1999,
when Microsoft released its Windows 98 Second Edition.
The European Commission found Microsoft liable for abusive tying of
its personal computer operating system and its streaming media player. Of
the offense’s four elements, the focus was on the second element (the tied
and tying products are two separate goods).84 The first and third elements
of abusive tying were not at issue. Microsoft’s dominant position in the
operating system market (the tying product) was not seriously disputed.
Nor was the third element, namely that Microsoft did not give customers a
choice to obtain the tying product without the tied product, seriously
contested. In both the U.S. and EU, one evil of tying is the monopolist
“affords consumers no choice but to purchase” (not so much to use85) the
83
U.S. v. Microsoft Corp., 84 F. Supp. 2d 9, 30 (D.D.C. 1999), affirmed in part,
reversed in part, 253 F.3d 34 (D.C. Cir. 2001).
84
Microsoft argued that liability would punish dominant undertakings from improving
their products by integrating new features in them. A dominant firm, argued Microsoft,
would be obligated to remove its innovations whenever a third party marketed a standalone
product that provided the same or similar functionalities. CFI Microsoft ¶ 888. The United
States Court of Appeals for the D.C. Circuit was sympathetic to Microsoft’s claims. The
Court held that the per se illegality standard should not apply to Microsoft’s tying its
Internet web browser, Explorer, to its operating system. The Court remanded for a more
lenient rule of reason standard, and the United States and Microsoft settled.
85
CFI Microsoft Decision ¶ 970 (“neither Article 82(d) EC nor the case-law on
bundling requires that consumers must be forced to use the tied product or prevented from
using the same product supplied by a competitor of the dominant undertaking in order for
the condition that the conclusion of contracts is made subject to acceptance of
supplementary obligations to be capable of being regarded as satisfied”).
22
Behavioral Economics and Dynamic Competition
[8-FEB-16
tied product.86 Microsoft’s Windows Media Player came with the operating
system. Neither computer manufacturers (OEMs) nor consumers could
remove the Windows Media Player.87
What is interesting for our purposes is the offense’s fourth element,
namely that Microsoft’s tying practice foreclosed competition.
The
European Commission, like the district court in the U.S. case, observed how
the industry was characterized with network effects. One complaint was
that with its operating systems monopoly (enforced by network effects),
Microsoft could ward off potential threats by tying its imitation product.
Once Microsoft added its version, the Commission found, programmers will
develop solutions for the Microsoft platform because it will reach
automatically 90% of client PC users, and thus save the content providers
the costs of supporting different technology platforms. Under this positive
feed-back loop, more users of a given software platform lead to a greater
incentive to develop products compatible with that platform, which
reinforces that platform’s popularity with end-users (and the software
company’s market power).
Thus Microsoft chilled the incentives for
potential innovators to challenge the entrenched monopolist.
As the
Commission argued and Court of First Instance found, such bundling
“discourages investment in all the technologies in which Microsoft could
conceivably take an interest in the future.”88
But from a rational choice perspective, it is difficult to see the coercion
or foreclosure one typically finds in tying claims. It was uncontested that
consumers, after unpacking the computer and starting it up, could search the
Internet for the media player they want, download the software to their
86
Cite Microsoft, Kodak, Jefferson Parish. The evil is in coercing the consumer to
purchase the tied good. CFI Microsoft ¶ 865 (noting how coercion was mainly applied first
of all to OEMs, who then pass it on to the end user).
87
CFI Microsoft ¶¶ 832, 837.
88
Microsoft, 2007 E.C.R. II-3601.
8-Feb-16]
Behavioral Economics and Dynamic Competition
23
computer, and use that media player for listening to music or watching
videos.89 Consequently, the issue was to what extent did the monopolist
foreclose competition when consumers could download (often for free)
alternative media players on the Internet.90
Nor were consumers or the OEMs disadvantaged if they opted for an
alternative media player.91
After the U.S. antitrust consent decree,
Microsoft could not design its operating system to hamper rival media
players, as it earlier did with its Internet browser. Nor could Microsoft
contractually require software developers, content providers or anyone else
to distribute or promote exclusively or mainly its Windows Media Player.92
It was undisputed that Microsoft’s operating system could run one or more
media players without affecting the media players’ performance.93 Nor
were consumers forced to use Microsoft’s Windows Media Player.
Consumers could set another media player as the default option.94 As the
Commission and Court of First Instance observed, a “not insignificant
number of customers continue to acquire media players from Microsoft’s
competitors, separately from their client PC operating system, which shows
89
CFI Microsoft ¶ 829. Moreover media players may be sold in retail outlets or
distributed with other software products. CFI Microsoft ¶ 830.
90
The Commission questioned the extent the media players were free: “Third-party
media players offering all the functionality of WMP are often not given away for free.
Microsoft’s argument that ‘media player vendors have business models in which they give
away most copies of their products’ therefore has to be taken with a degree of caution. It
would indeed appear that users feel still less inclined to buy a second media player - even
though it offers more functionality than a basic free version of the same brand - where they
have already obtained a comparable full-fledged media player pre-installed on their PC.”
EC Decision ¶ 847 (footnotes omitted). Consumers today can download a free copy of
RealPlayer
(http://www.real.com/realplayer),
QuickTime
(http://www.apple.com/quicktime/download/),
and
other
media
players
(http://download.cnet.com/windows/media-players/).
91
CFI Microsoft ¶ 995.
92
CFI Microsoft ¶ 995 (no exclusivity provisions).
93
CFI Microsoft ¶ 993.
94
CFI Microsoft ¶ 952.
24
Behavioral Economics and Dynamic Competition
[8-FEB-16
that they regard the two products as separate.”95 At the time of litigation,
consumers used on average 1.7 media players each month, and that number
was increasing.96
One could strain under rational choice theory to find some coercion.
First, rational consumers must devote some time and effort to download a
media player,97 which could take longer for users without broadband
Internet service. Second, OEMs and consumers could not delete Windows
Media Player from Microsoft’s Windows operating system. Any media
player would be in addition to Microsoft’s product.98 Thus, consumers
were unable to devote this computer memory, used by Microsoft’s media
player, for other purposes. Third, Microsoft devised its software so that its
Windows Media Player could override the consumer’s default setting and
reappear when the consumer used Microsoft’s Internet Explorer to access
media files streamed over the Internet.99
While annoying, these factors hardly justify a finding of coercion or
foreclosure. If other media players offered superior performance for free
(or at an attractive price), then rational consumers would incur these minor
costs to install and use a competing media player. Put simply, the benefits
of using a competing media player outweigh the costs to download it (and
use up some additional computer memory).
Accordingly, rational
consumers would switch if alternative media players indeed were
objectively of “better quality.”100 Since rational consumers would switch to
superior media players, then logically software programmers and music
companies would continue to support the superior players’ formats;
95
CFI Microsoft ¶ 932.
CFI Microsoft ¶ 953.
97
EC decision ¶ 866-67. The scarcity of broadband Internet, slower download times,
and failed downloads also may have contributed to consumers’ sticking with the default.
98
CFI Microsoft ¶ 946.
99
CFI Microsoft ¶ 974.
100
CFI Microsoft ¶ 971.
96
8-Feb-16]
Behavioral Economics and Dynamic Competition
25
Microsoft’s attempt to thwart the competitive threat of middleware (or
leverage its monopoly to the media player market) would fail.
Many consumers, however, did not (i) purchase Windows N (the
version of Microsoft’s operating system without its Windows Media
Player), and (ii) download RealNetworks’s and Apple’s competing media
players when they readily could have. But this too is explainable under
rational choice theory: these facts are consistent with competition on the
merits.
Rational consumers could and would easily switch to superior
media players.
If actual consumers are rational and if many did not
download other media players, one can deduce that Microsoft’s Windows
Media Player was as good as, if not superior to, competing media players.
Herein lies the problem. Windows Media Player’s growth, as Microsoft
itself recognized, was not attributable to its superior quality to rival
products or that the rival products, in particular RealPlayer, had defects.101
“In fact, Microsoft’s own October 2003 submission illustrates that the
reviews
presented
(1999-2003)
rate
the
best
product
to
be
RealNetworks’ player more often than WMP.”102 Consequently, rational
choice theory cannot explain actual consumer behavior.
For a rational choice theorist, the default option (assuming low
transactions costs) should not matter.
Whatever the default option,
consumers would readily opt for their preferred option, which here would
be the superior media player. If many consumers preferred Windows Media
Player, but OEMs installed RealNetworks’s player, then consumers would
switch to Windows Media Player.
But as the behavioral economics literature shows, the setting of the
default can often determine the outcome (even when transaction costs are
101
102
CFI Microsoft ¶ 1057.
EC Microsoft ¶ 948.
26
Behavioral Economics and Dynamic Competition
[8-FEB-16
nominal).103 Default options have played an important role in participation
and investments in retirement savings, contractual choices in health-clubs,
organ donations, and car insurance plans.104 With different views (until
perhaps recently) of the benefits of class actions, the EU and the U.S. have
different preferences of class members opting out versus opting into the
class.105
The district court in the Google book search action recently
observed that many concerns over the proposed settlement would be
“ameliorated” if the settlement were converted from an “opt-out” to an
“opt-in” settlement.106 Not surprisingly, firms and consumers can have
different preferences over the default option. In the Federal Reserve’s
testing, for example, the majority of surveyed participants preferred setting
the default as consumers having to opt into the bank’s overdraft program
rather than having to opt out (which many banks preferred).107
In Microsoft, the monopolist preferred having its inferior media player
as the default option requiring consumers to opt into an alternative media
player. As Microsoft recognized, some consumers would reject the default
103
RICHARD H. THALER & CASS R. SUNSTEIN, NUDGE: IMPROVING DECISIONS ABOUT
HEALTH, WEALTH, AND HAPPINESS 78 (2008); Camerer et al., supra note Error!
Bookmark not defined., at 1211.
104
SUNSTEIN & THALER, NUDGE, supra note 103, at 129-30; Stefano DellaVigna,
Psychology and Economics: Evidence from the Field, 47 J. ECON. LIT. 315, 322 n.11
(2009); Eric J. Johnson et al., Defaults, Framing and Privacy: Why Opting In-Opting Out,
13 MARKETING LETTERS 5-15 (2003) (consent to receive e-mail marketing); C. Whan Park
et al., Choosing What I Want Versus Rejecting What I Do Not Want: An Application of
Decision Framing to Product Option Choice Decisions, 37 J. MARKETING RES. 187-202
(2000) (car option purchases).
105
European Consumer Consultative Group, Opinion on Private Damages Actions 4
(2010) (noting Europe’s recent experience that the rate of participation in opt-in procedure
for consumer claims was less than one percent, whereas under opt-out regimes, rates are
typically very high (97% in the Netherlands and almost 100% in Portugal)),
http://ec.europa.eu/consumers/empowerment/docs/ECCG_opinion_on_actions_for_damage
s_18112010.pdf.
106
Authors Guild v. Google Inc., Civ. Act. No. 05 Civ. 8136, slip op. at 46 (S.D.N.Y.
Mar. 22, 2011).
107
Board of Governors of the Federal Reserve System, Final rule; official staff
commentary,
12
C.F.R.
Part
205,
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20091112a1.pdf.
8-Feb-16]
Behavioral Economics and Dynamic Competition
27
option and download a rival media player. But many simply would stick
with the default option. Consequently, the Court of First Instance
recognized that consumers “who find Windows Media Player pre-installed
on their client PCs are generally less inclined to use another media
player.”108 The EC was blunt: “A supply-side aspect to consider is that,
while downloading is in itself a technically inexpensive way of distributing
media players, vendors must expend resources to overcome end-users’
inertia and persuade them to ignore the pre-installation of WMP.”109 Not
only is inertia (status quo bias) at work. Some non-computer savvy
consumers may believe that default option represents the deliberate choice
by the OEM to include the superior media player.110 Status quo bias
explains why many consumers remain with the default option, even though
rational choice theory predicts that they would download the superior rival
media browser.
Although the facts did not support its rational choice theory, Microsoft
argued that the facts contradicted the Commission’s behavioral explanation.
Downloading was a viable mechanism to distribute a media player,
Microsoft argued, as “more than 100 million copies of WMP 9 were
downloaded in the ten months the software was available to the general
public.”111 The EC noted that these “copies were downloaded by people
who already had a version of Windows Media Player installed on their
PCs.”112 If bounded rational consumers remain with the default option, then
logically consumers would stick not only with the default media player, but
also with that version of the media player. If Microsoft users overcame
108
CFI Microsoft ¶ 980.
EC Microsoft ¶ 870, quoted in CFI Microsoft ¶ 1052.
110
CFI Microsoft ¶ 1050.
111
EC
decision
¶
http://ec.europa.eu/competition/elojade/isef/case_details.cfm?proc_code=1_37792
112
EC
decision
¶
http://ec.europa.eu/competition/elojade/isef/case_details.cfm?proc_code=1_37792
109
864,
864,
28
Behavioral Economics and Dynamic Competition
[8-FEB-16
status quo bias to upgrade their default media player, arguably they could
upgrade to any media player. But here Microsoft did not rely on consumers
to search for and download software updates. Instead Microsoft nudged its
consumers. Microsoft implemented a mechanism in its Windows Media
Player by which the player independently and regularly looked for upgrades
on Microsoft’s Web site, and prompted the user to download it.113
Moreover, since consumers procrastinate, Microsoft “repeatedly” prompted
the consumer to download the upgraded WMP 9 if consumers chose not to
do so at the first prompt.114
Thus as the European Commission recognized, the default option
matters. Regulators and the industry will continue to battle over whether
consumers need to opt-out or opt-in. For if Microsoft seriously considered
downloading as “an equivalent alternative to pre-installation,” observed the
European Commission, then Microsoft’s “insistence on maintaining its
current privilege of automatic pre-installation appears inconsistent.”115
Besides status quo bias, there is also the sunk cost fallacy. Consumers,
under rational choice theory, “ignore sunk costs (costs that cannot be
recovered, such as the cost of nonrefundable tickets).”116
Consumers
should instead consider the costs and benefits going forward. To illustrate:
Assume that you have spent $100 on a ticket for a weekend ski
trip to Michigan. Several weeks later you buy a $50 ticket for a
weekend ski trip to Wisconsin. You think you will enjoy the
Wisconsin ski trip more than the Michigan ski trip. As you are
putting your just-purchased Wisconsin ski trip ticket in your
wallet, you notice that the Michigan ski trip and the Wisconsin ski
trip are for the same weekend! It’s too late to sell either ticket, and
you cannot return either one. You must use one ticket and not the
other. Which ski trip will you go on?117
113
EC decision ¶ 864.
EC decision ¶ 864.
115
EC Decision ¶ 871.
116
Jolls et al. supra note, at 1482.
117
Hal R. Arkes & Catherine Blumer, The Psychology of Sunk Cost, 35 ORG. BEHAV.
114
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Behavioral Economics and Dynamic Competition
29
Under rational choice theory, the $50 and $100 costs are effectively
sunk. Consumers instead would consider the costs/benefits going forward
and opt for the more enjoyable Wisconsin ski trip. But more people, in
response to this question, chose the Michigan trip.118 Bounded rational
firms, governments, and consumers “throw good time and money after bad
even when the logical decision is to cut bait.”119
Monopolists also can use the sunk cost fallacy to maintain their
monopoly.
Consumers, for example, can invest significant costs in
downloading songs and movies, creating play lists, and organizing their
music and videos in their media players. These costs are effectively sunk if
consumers cannot transfer their media library to a rival player. Originally
Microsoft’s media player was compatible with rivals. But Windows Media
Player no longer supported the formats of its rivals’ media players. For
rational consumers, the sunk costs invested in Windows Media Player are
irrelevant. Knowing they will continue to download music and movies,
consumers would consider the benefits and costs going forward with the
different media players. But bounded rational consumers, under sunk cost
fallacy, would not want to waste their prior time, expense and effort; so they
continue using Windows Media Player until a new disruptive innovation
(like the iPod, iPhone, and iPad) comes along.120
& HUM. DECISION PROCESSES 124, 126 (1985).
118
Arkes & Blumer, supra note **, at 126 (33 opted for Michigan v. 28 for
Wisconsin).
119
Malcolm Baker et al., Behavioral Corporate Finance: A Survey 49 (Sept. 29, 2005),
http://ssrn.com/abstract=602902; Janky v. Batistatos, 2008 WL 4411504, at *1 (N.D. Ind.
Sept. 25, 2008) (noting how “from the acorn of a relatively minor copyright dispute a
mighty oak tree of litigation has resulted-two federal cases, three federal appeals, a state
case, and several rounds of sanctions”).
120
Interestingly, Apple is currently being sued for encoding its digital music files with
its proprietary digital rights management software that only allowed digital music files
purchased from Apple’s iTunes Store to be played directly on iPods; the files could not be
played directly on competitors’ digital music players. Apple allegedly prevented digital
30
Behavioral Economics and Dynamic Competition
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To lock-in consumers, monopolists can proactively remind bounded
rational consumers of the sunk costs (e.g., how many installments they
already paid for their appliances, furniture, or home, to induce them to
continue paying installments), even though the consumer going forward
would be better off opting out (e.g., item’s value is less than the remainder
of payments). Thus the sunk cost fallacy magnifies the switching costs,
thereby increasing the “locked-in” effect and the level of price increases (or
reduced quality or services) bounded rational consumers tolerate before
switching brands.121
One issue with status quo bias is determining an appropriate remedy. In
the Commission’s Microsoft case, the remedy was criticized as
ineffectual.122
The Commission, as Microsoft argued, would not have
found an abusive tie if Microsoft offered at the same price two versions of
its operating system: one with Windows Media Player and one without.123
As its principal remedy, the Commission required Microsoft to allow
consumers to obtain a version of its operating system without its media
player, “a measure which does not mean any change in Microsoft’s current
technical practice other than the development of that version of
music files sold at other companies' online music stores from being played on iPods.
Plaintiffs in the private antitrust claim allege that Apple sought to foreclose RealNetworks,
which in 2004, announced that its digital music files could be played on iPods. When
Apple's updates to the software were released in October 2004, plaintiffs allege that “users
were forced to update their iTunes applications and iPods, the digital music files from
RealNetworks's online store were no longer interoperable with Apple's iPods.” Apple iPod
iTunes Antitrust Litigation, Slip Copy, 2011 WL 976942, at *1 (N.D. Cal. March 21,
2011).
121
Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451 (1992).
122
Kevin J. O'Brien, As EU Debated, Microsoft Took Market Share, N.Y. Times, Sept.
16,
2007,
at
http://www.nytimes.com/2007/09/16/business/worldbusiness/16ihtmsft17.1.7522119.html (noting that settlement perceived as a “commercial flop”); Frederic
M. Scherer, Abuse of Dominance by High Technology Enterprises: A Comparison of U.S.
and E.C. Approaches, 38 J. Indus. and Bus. Econ. 39, 45 (2011) (characterizing remedy as
“an abject failure”).
123
CFI Microsoft ¶ 891. The EC denied making this admission in its decision. Id. at ¶
908.
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Behavioral Economics and Dynamic Competition
31
Windows.”124 As Microsoft accurately predicted, no one would demand the
operating system without the media player.125 This lack of demand, argued
Microsoft to the Court of First Instance, supported its contention that
“’Windows with media functionality’ is a single product.”126
One need not be a behavioral economist to predict the shortcomings of
the Commission’s remedy.
But the remedy shows the importance of
prospect theory’s framing effects and the reference point. Prospect theory
predicts that consumers’ response will vary if the option is perceived as
avoiding a loss (consumers are more risk seeking) or as a sure gain
(consumers are more risk adverse). Losses closer to a reference point hurt
more than twice the joy from comparable gains. So if one could measure
joy and pain in standard units (say utils), prospect theory predicts that the
pain one feels in losing $100 is more than twice the joy one would feel in
finding $100.127
Whether the remedy is perceived as a loss or a gain depends on the
reference point.128
124
Microsoft effectively set the reference point as the
EC PRESS RELEASE No 63/07, Judgment of the Court of First Instance in Case
T-201/04, Microsoft Corp. v Commission of the European Communities, 17 September
2007,
http://europa.eu/rapid/pressReleasesAction.do?reference=CJE/07/63&format=HTML&age
d=0&language=EN&guiLanguage=en.
125
CFI Microsoft ¶ 891.
126
CFI Microsoft ¶ 891.
127
Kahneman, supra note Error! Bookmark not defined., at 1456.
128
Kahneman et al., supra note **, at 257. One sees the importance of the reference
point for merchants accepting credit cards. The merchant bears different cost for accepting
different credit card. The merchant has two ways to characterize the reference point: first
as a lower cash price and impose a surcharge for customers using a credit card with a
higher interchange fee. Alternatively, the merchant can set the credit price as the reference
point, and offer consumers a discount if they paid with cash (or a credit or debit card with a
lower interchange fee). Since the net price is the same, how the choice is framed should not
affect the outcome. After the credit card companies' No-Discrimination Rule was
abolished, Dutch merchants could impose surcharges or offer discounts, based on how the
customer was going to pay. Over seventy percent of the merchants surveyed were unaware
of the rule's abolition, and eighty-nine percent of the merchants did not surcharge
customers. Nine percent of the merchants offered discounts to customers who paid by
different means. Of the consumers surveyed, seventy-four percent thought it (very) bad if a
32
Behavioral Economics and Dynamic Competition
[8-FEB-16
bundled product, namely an operating system with a media player. Thus
the Commission’s remedy was a perceived loss in two aspects: getting a
“degraded” product (the Windows product without a media player)129 and
effectively paying more for it.
Since losses (here the loss of one media
player) hurt more than comparable gains (adding one media player of one’s
choosing130), the European Commission’s remedy was likely to fail. The
Commission put itself in an awkward position when it chose as the
reference point the basic unbundled operating system. The Commission
argued that consumers and OEMs could choose which competitor’s media
player, if any, they wanted. Although the Commission properly insisted
that the operating system and media player were two separate products, they
were nonetheless complementary products. The Commission implicitly told
consumers to settle for less (simply an operating system). Alternatively, the
Commission could have required consumers to pay more for the Windows
operating system with Windows Media Player, but this remedy increases
the Commission’s regulatory role for a product that is freely available on
the Internet.131 Neither option is desirable.
Instead, using prospect theory, the European Commission should have
moved the reference point in the opposite direction such that consumers
would have perceived Microsoft’s reference point as a loss.
The
Commission never asserted that operating systems and media players were
unrelated. Rather, the Commission asserted that it was not necessary for
merchant asked for a surcharge for using a credit card. But when asked about a merchant
offering a discount, only forty-nine percent thought it (very) bad, with twenty-two percent
neutral and twenty-one percent saying it is a (very) good thing. ITM Research, The
Abolition of the No-Discrimination Rule at 7-8 (March 2000), http://
ec.europa.eu/comm/competition/antitrust/cases/29373/studies/netherlands/report.pdf.
129
CFI Microsoft ¶ 1171
130
The EC believed that OEMs would respond to consumer expectations by preinstalling another media player on the version without Windows Media Player. CFI
Microsoft ¶ 1204.
131
CFI Microsoft ¶ 968.
8-Feb-16]
Behavioral Economics and Dynamic Competition
33
Microsoft’s media player to be bundled with its operating system. Thus, the
Commission could have established as the reference point an operating
system that came with several choices of media players, from which users
could chose.
With this reference point, a Windows operating system that
comes only with Windows Media Player is a perceived loss (and the loss of
two options hurts more than the pleasure gained from one option); moreover
consumer prefer having some choices rather than having no choice.
The Commission learned from its mistake, and experimented with this
other reference point when it later challenged Microsoft for tying its web
browser, Internet Explorer, to its personal computer operating system,
Windows.132 Before the settlement, consumers who used Windows had
Microsoft’s Internet Explorer as their default web browser.
Although
consumers could download other Internet browsers, many did not, a
function not attributable necessarily to the superiority of Microsoft’s
browser but status quo bias.133 Rather than using its earlier reference point
(namely an operating system without a browser), the Commission
effectively shifted to the superior reference point: “’The commission had
suggested to Microsoft that consumers be provided with a choice of web
browsers,’ the EC wrote regarding the standalone software proposal.
‘Rather than more choice, Microsoft seems to have chosen to provide
less.’”134
As part of its settlement, Microsoft for five years must provide
132
Press Release, European Commission, Antitrust: Commission Welcomes
Microsoft's Roll-Out of Web Browser Choice, IP/10/216 (Mar. 2, 2010),
http://europa.eu/rapid/pressReleasesAction.do?reference=IP/10/216&format=HTML&aged
=0&language=EN.
133
Shane Frederick, Automated Choice Heuristics, in HEURISTICS AND BIASES: THE
PSYCHOLOGY OF INTUITIVE JUDGMENT 555 (Thomas Gilovich et al. eds. 2002)
(summarizing experimental evidence of peopling preferring current options over other
options to a degree that is difficult to justify).
134
Ryan Singel, EU Criticizes Microsoft’s IE Unbundling, but Does It Matter
Anymore?, Wired, June 12, 2009, http://www.wired.com/epicenter/2009/06/eu-criticizesmicrosofts-ie-un-bundling-but-does-it-matter-anymore/
34
Behavioral Economics and Dynamic Competition
[8-FEB-16
consumers within the European Economic Area a Browser Choice Screen.
Rather than having one Internet browser as the default, computer users must
choose whether they want a browser, and if so, which browser they want to
install from the competing web browsers listed on the screen.135 Identified
are five Internet browsers, with a short description of each, along with links
for further information.136
The European Commission’s browser remedy is superior under prospect
theory to its earlier media player remedy. But it remains unclear how
successful the settlement has been to date. On the one hand, Microsoft’s
share of the European browser market declined after the settlement--from
44.9 percent in January 2010 to 39.8 percent in October 2010. 137 Thus
Microsoft has a lower market share in the European Union, where
consumers are given a choice, than elsewhere in the world where consumers
with the Windows operating system must continue downloading an
alternative browser.138 Moreover, according to one report, downloads of
Opera Software’s desktop browser “increased in number significantly after
Microsoft started offering Windows users in Europe a choice in browser
with a so-called ballot screen” with “on average, more than half of the
European downloads of Opera’s latest browser com[ing] directly from that
Choice Screen.”139 The remedy, by enabling consumers to easily choose
135
Summary of Commission Decision of 16 December 2009 relating to a proceeding
under Article 102 of the Treaty on the Functioning of the European Union and Article 54 of
the EEA Agreement (Case COMP/39.530 — Microsoft (Tying)) (2010/C 36/06).
136
http://www.browserchoice.eu/BrowserChoice/browserchoice_en.htm.
137
In 2009, Microsoft’s share declined by 5.5 percentage points; in 2008 by 8 points.
Kevin J. O'Brien, European Antitrust Deal With Microsoft Barely Affects Browser Market,
N.Y.
TIMES,
Oct.
10,
2010,
http://www.nytimes.com/2010/10/11/technology/11eubrowser.html?ref=business.
138
As of April 2011, Microsoft’s Internet Explorer accounted for 55.11 percent of the
global usage of browsers, Mozilla's Firefox had 21.63 percent, Google's Chrome had 11.94
percent, and Apple's Safari held 7.15 percent. http://marketshare.hitslink.com/browsermarket-share.aspx?qprid=0&qptimeframe=M
139
http://techcrunch.com/2010/03/18/microsofts-european-browser-choice-screencauses-spike-in-opera-downloads/.
8-Feb-16]
Behavioral Economics and Dynamic Competition
35
which browser they desire, increases the likelihood that the market share
reflects
more the consumers’ informed choice, rather than the
monopolist’s.140
On the other hand, even before the settlement, Microsoft’s browser
market share was declining.141 So Microsoft’s share could have declined
absent the remedy. Moreover, while providing consumers some choice is
better than no choice, the choice remedy has at least two limitations. First,
offering too many choices can be self-defeating.
For example, having
consumers choose among 16 web browsers may lead to a worse outcome
than choosing among five.
Consumers may demand more choices than
they actually prefer.142 Again under loss aversion, consumers hate giving
up options and restricting their choice set. But when faced with many
choices, some bounded rational consumers avoid choosing any option, even
when the choice of opting out has negative consequences for future wellbeing.143 Other consumers choose an option, but have lower confidence in
their choice and greater dissatisfaction in choosing. Thus too many choices
140
Emanuele Ciriolo, Behavioural Economics in the European Commission: Past,
Present and Future, OXERA AGENDA, Jan. 2011, at 3 (noting how 25% of the consumers
who
viewed
the
Choice
Screen
chose
an
alternative
browser),
http://www.oxera.com/main.aspx?id=9324.
141
Id.
142
In one computer experiment, participants tried to keep options open even when
counter-productive. ARIELY, supra note Error! Bookmark not defined., at 142-48. In
the Door Game, each MIT student could click on three doors on the computer screen to
find the room with the biggest payoff (between 1 and 10 cents). Each student was given
100 clicks, and could click one door as many times possible without a penalty. Each time
the student sampled another door, that switch cost the student one additional click.
Experiment 2, the Disappearing Door Game, was the same as the Door Game except each
time a door was left unvisited for 12 clicks, it disappeared forever. To keep options open,
participants in Experiment 2 ended up making substantially less money (about fifteen
percent less) than participants in Experiment 1. Participants would have made more money
by sticking to one door. Id. at 147. A similar result occurred when participants were told
the exact monetary outcome they could expect from each room.
143
Simona Botti & Sheena S. Iyengar, The Dark Side of Choice: When Choice Impairs
Social Welfare, 25 J. PUBLIC POL’Y & MARKETING 24, 26 (2006) (discussing information
overload, where an increase in options raises the cognitive costs in comparing and
evaluating the options and leads to suboptimal decision strategies).
36
Behavioral Economics and Dynamic Competition
[8-FEB-16
may lead to suboptimal results for consumers and firms.144
A second shortcoming with the Commission’s choice model is the lack
of any feedback loop, whereby consumers can test the products and
compare their performance. For search engines, the consumer can see the
number and quality of results for a search term. But benchmarking web
browsers and media players may be harder. To the extent the choice screen
provides consumers a way to compare the products’ performance on
popular metrics, the more likely the consumer’s choice will be informed.
One may question the extent to which defaults matter going forward for
technological innovation. Consumers arguably are more comfortable with
computer technology.
Indeed Apple’s Steve Jobs discusses the post-
Personal Computer world of handheld devices,145 where Microsoft is
lagging.146 Many consumers today search and download apps for their
mobile telephones, iPods, and iPads; “the average number of apps
downloaded to every iPhone/iPod touch and iPad is more than 60.”147
Downloading itself may become dated with cloud computing. It is fitting
that the same week that the United States antitrust consent decree with
144
The bounded rational firms, as a result, lose sales opportunities of their products.
Iyengar and Lepper, in their famous experiment, set up a tasting booth in an upscale
grocery store. The booth displayed either six or twenty-four different flavors of jam. A
greater percentage of the shoppers stopped to sample one of the displayed jams when the
booth had twenty-four jam flavors (60 percent versus 40 percent when booth displayed six
jam flavors). But a lower percentage actually purchased a jar of jam (3 percent versus 30
percent of customers when booth had only six flavors). Sheena S. Iyengar & Mark R.
Lepper, When Choice Is Demotivating: Can One Desire Too Much of a Good Thing?, 79 J.
PERSONALITY & SOC. PSYCHOL. 995–1006 (2000).
145
Brier Dudley, Feisty Steve Jobs Talks Up Apple's 'post-PC' iPad 2, Seattle Times,
March
2,
2011,
http://o.seattletimes.nwsource.com/html/businesstechnology/2014381153_brier03.html.
146
In a recent Nielsen survey of U.S. mobile consumers for January 2011 to March
2011, 31 percent of consumers who plan to get a new smartphone indicated that Android
was now their preferred operating system, 30 percent preferred Apple’s iOS, 11 percent
identified RIM/Blackberry, and 6 percent identified Windows Phone devices (nearly 20
percent were unsure what to choose next). http://techcrunch.com/2011/04/26/nielsenconsumer-desire-for-android-grows-unlike-ios-and-blackberry/
147
BRYAN M. WOLFE, The Number Of Apps Downloaded Each Day Reaches 30
Million, Jan. 20, 2011,
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Behavioral Economics and Dynamic Competition
37
Microsoft expired, two other things happened. First, Google announced its
Chromebook, whereby the user accesses its data and applications through
the Internet. The computer has no operating system (which would require
downloads, updates, etc.). As advertised none of the consumer’s data is
lost, if the computer falls in a lake.
Second, Microsoft announced its
purchase of Skype. Microsoft hopes Skype will provide greater inroads in
social networks, which like Facebook, the most popular visited site, do not
require downloads, but can be accessed anywhere.148
Nonetheless defaults will continue to be an issue. Competitors in South
Korea, for example, have complained to the Korean FTC of Google offering
its Android system for free with smartphones.149 Android smartphones use
Google as the default search engine.150 Although it its technically possible
to switch to competing search applications, the competitors argue, as did
Microsoft’s competitors in the earlier antitrust cases, that it is not easy. 151
They complain that their applications cannot be preloaded on the
smartphone.152
CONCLUSION
Dynamic competition with bounded rational market participants is
inherently complex and difficult to predict. We can only comprehend the
competitive process imperfectly. But by updating competition policy with
the developments of behavioral economics we can see the importance of
feedback loops and adaptation to the competitive process as well as a
potential entry barrier. Antitrust analysis accordingly must move beyond
rational choice theory to assess the behavior observed in the marketplace.
148
Richard Waters et al., Micosoft Pays $8.5bn for Skype in Push for Consumer
Internet Control, Fin. Times, May 11, 2011, at 1.
149
McDonald, supra note **, at B3.
150
McDonald, supra note **, at B3.
151
McDonald, supra note **, at B3.
152
McDonald, supra note **, at B3.
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Behavioral Economics and Dynamic Competition
[8-FEB-16
Besides the recognized arsenal of practices to illegally maintain their
monopolies, monopolists can exploit consumer biases and heuristics, such
as status quo bias and the sunk cost fallacy, to attain or maintain their
monopoly.
Ultimately the issue involves incentives. Bounded rational firms, as this
Article discusses, have an incentive to improve their rationality and
willpower when debiasing provides a competitive advantage.
government often lacks this incentive.
But the
At times competition agencies
compete for prestige, resources, and cases (such as the FTC and DOJ over
mergers).
But inter-agency competition does not necessarily increase
political accountability and reduce the government’s biases and
heuristics.153
Although the competition agencies may attract dynamic
leaders with a desire to critically test the prevailing economic theory’s
assumptions, there are no built-in institutional mechanisms that will
regularly the incentives for government officials to recognize their bounded
rationality, to continually test their theories’ assumptions, to retrospectively
examine the efficacy of their actions, and to use these findings to update
their policies.154
Consequently, while competition can supply firms the incentive to
debias, competition agencies must now design institutional mechanisms to
engage in the same trial-and-error feedback loop.
While some may argue
boring, antitrust enforcement requires patient gardeners, who experiment,
monitor, and update the economic theories of competition, entry barriers,
and monopolization.
153
When test subjects were expected to defend their judgments to their peers, subjects
chose more complex and time-consuming decision-making strategies. Ziva Kunda, The
Case for Motivated Reasoning, 108 PSYCHOLOGICAL BULL. 480, 481(1990).
154
NORTH, UNDERSTANDING, supra note Error! Bookmark not defined., at 68.