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Does the OS Want To Be Free?

Google-Motorola

When Google’s proposed acquisition of Motorola Mobility was announced in 2011, the business press focused mainly on the extension of Google’s core business from Internet search into hardware. But from a legal perspective, the treatment given the deal by competition authorities in the United States, the EU and China raises intriguing questions about the scope and objectives of merger policy in emerging technology markets.

The acquisition represents a classic case of downstream vertical integration into complementary markets. Since Google’s aborted launch of its own “Nexus One” smartphone in 2010, Google’s presence in the wireless handset and other hardware markets has been minimal. Merger reviews typically focus on horizontal concentration in a relevant product market; namely, to evaluate the risk that an increase of concentration post-transaction may produce a rise in prices or other so-called “coordinated effects.” There has been virtual unanimity among antitrust scholars and enforcement authorities for several decades that vertical integration typically presents little or no antitrust risk.

That is a principal result of the Chicago School antitrust revolution, ushered into American antitrust law and policy by GTE Sylvania in 1977. Under this approach, vertical restrictions and other relationships between manufacturers, distributors and retailers are presumptively procompetitive by increasing incentives for interbrand competition. Although technically classified as a “rule of reason” analysis, in reality the leniency of American antitrust law to vertical restraints has been such that there are almost no significant examples (with a few exceptions, like the Microsoft monopolization case of 1998-2000) of vertical restraints or mergers being judged to violate the Clayton Act or the Sherman Act.

So it should come as little surprise, therefore, that from an antitrust perspective Google’s proposal to acquire Motorola Mobility raised very few eyebrows. Yet just weeks ago it was announced that Google had received final approval to close the deal from the new China Competition Authority (the Ministry of Commerce, Anti-Monopoly Bureau ), contingent on one important concession. The Chinese required that Google pledge to maintain its Android operating system (OS) on a free basis for all wireless device manufacturers for the next five years.

The evident competition concern here is behavioral, not structural. That is, there is no risk that post-merger, Google’s share of either its own markets or Motorola’s markets will exacerbate coordinated affects or give it enhanced unilateral market power. To the contrary, the competitive risk potentially feared by antitrust regulators or competitors is that once it has a presence in wireless device manufacturing, Google might favor its own financial and competitive interests downstream by beginning to charge device manufacturing rivals for the Android OS.

This presents two provocative issues. First, should merger enforcement policy be grounded in a prediction of the post-transaction business incentives of the merging parties? While merger analysis must necessarily be based on a prediction of future effects, projecting the future business behavior of any one firm is far more problematic and unreliable than the kind of structural market analysis informed by HHI and oligopoly economics. And in most if not all antitrust regimes, even if the merger itself is accorded clearance by competition authorities, governments and competitors still have the opportunity to challenge actual post-merger conduct as a violation of the antitrust laws. Especially in rapidly changing technology markets — of which wireless handsets are undoubtedly a leading example — the risk of error in basing merger policy on predictions of future business behavior seems rather high.

The second issue raised by Chinese approval of the Google-Motorola deal is whether antitrust enforcers can or should dictate price. Typically, it is assumed that antitrust policy relies upon marketplace competition to produce the most efficient allocation of resources and “correct” pricing. Even in per se illegal price-fixing cases, the government never independently decides what the “right” price should be, but rather steps in to redress cartels or other restraints that limit the ability of market forces to set price based upon supply and demand.

“Open source” software, however, seems to be an emerging exception to that settled rule. In Oracle’s 2009 acquisition of Sun Microsystems, competitive concerns were raised about whether Oracle might begin charging for Sun’s open source mySQL database software. In Google’s 2010 acquisition of ITA, a travel software developer, the U.S. Justice Department required as part of a consent decree settlement that Google agree to maintain ITA pricing to travel service rivals and to continue R&D for the software itself. While ITA represents proprietary, paid software, the same vertical pricing concerns animated the government’s response to that deal as well.

But who is to decide whether an OS, or any other software, must or should be offered for free? The business model case for open source — dating back to that pioneered by Netscape in the late 1990s, where the Web upstart offered its browsing software for free in order to capture share and profits from the sale of server software — has been that companies offer free products in order to monetize their investment at another level (typically upstream) of the distribution chain. Economics would therefore teach that, if as seems correct, Google could make more money from handset profits than licenses for its Android OS, its rational business incentives would be to maintain Android as a free, open source product.

There’s still a big difference between legacy command-and-control economies like China, despite its recent liberalizations, and the market-oriented economy of the United States. Yet with increasing globalization these sorts of conflicting world views are likely to become more prominent. Whether the OS wants to be free could become less important than whether some government or enforcement agency – probably not in the U.S., one hopes – makes it their job to supplant the marketplace and dictate the answer.

Note: Originally written for my law firm’s Information Intersection blog.

 

Patent Wars and Blackmail in Silicon Valley

With reality television all the rage, viewers may wonder why there’s been no reality series about the inbred high-tech ecosystem of Silicon Valley. There should be, because the reality of how our technology bastion really competes today — namely by patent litigation and acquisitions — is astonishing.

Last year Google, Apple, Intel and other leading Silicon Valley companies were targeted by federal antitrust enforcers for tacitly agreeing not to hire each other’s key employees. Such a conspiracy could have landed top executives in jail. This year Apple, Samsung, Google, Nokia and others have all been battling over back-and-forth claims that smartphones and wireless tablets infringe each others’ U.S. patents. Now, just weeks after Google’s general counsel objected that patents are gumming up innovation, the search behemoth has announced its own $12.6 billion acquisition of Motorola Mobility, and with it their own portfolio of wireless patents, just a fortnight after purchasing a relatively few (“only” 1,000 or so ) wireless patents from IBM.

Patents

While the executives at Google have nothing to fear personally from these patent wars, others seem to have a lot at risk. That is because, according to the Wall Street Journal, the U.S. Justice Department’s Antitrust Division is investigating another possible conspiracy among Silicon Valley companies. This one arises out of the collective bid in the late spring of nearly every wireless phone operating system manufacturer, except Google, for a portfolio of 6,000 cell phone patents formerly held by bankrupt Canadian company Nortel. Simply put, Google started the bidding at about $1 billion, but the others joined forces to lift the price to an astounding $4.5 billion and win the prize.

That’s the legal background to Google’s just-announced Motorola Mobility acquisition, and it’s one that could have serious anticompetitive consequences. If the curiously named “Rockstar Bidco” consortium — which includes Microsoft, Apple, RIM, EMC, Ericsson and Sony — refuses to license the erstwhile Nortel patents to Google for its Android wireless operating system, they will be agreeing as “horizontal” competitors not to deal with a rival. Classically such group boycotts are treated as a serious antitrust no-no, and a criminal offense. If the group licenses the patents, on the other hand, they could be guilty of price fixing (also a possible criminal offense), since a common royalty price was not essential to the joint bid and would eliminate competition among the members for licensing fees.

If the Rockstar Bidco companies decide to enforce the patents by bringing infringement litigation against Google, things could be even worse. Patent suits themselves, unless totally bogus, are usually protected from antitrust liability so as not to deter legitimate protection of intellectual property assets. (That does not mean they’re competitively good, since patent suits are often just a means of keeping rivals out of the marketplace.) Nonetheless, a multi-plaintiff lawsuit by common owners of patents would have those same horizontal competitors agreeing on lots of joint conduct, well beyond mere license rates. For starters, is the objective of such an initiative to kill Android by impeding its market share expansion? That’s a valid competitive strategy, standing alone, for any one company; it takes on a totally different dimension when firms collectively controlling a dominant share of the market gang up on one specific rival.

Google’s broader complaint that patent litigation in the United States is too expensive, too uncertain and too long may well be right. This bigger issue is being debated in Washington, DC as part of what insiders call “patent reform.” The high-stakes competitive battles being waged today in the wireless space under the guise of esoteric patent law issues like “anticipation” by “prior art” suggest a thoroughly Machiavellian approach to the legal process, just as war is merely diplomacy by other means. They inevitably color the perspective of policy makers, who watch with regret as a system designed to foster innovation gets progressively buried with expensive suits, devious procedural maneuvering and legalized judicial blackmail.

Even the biggest companies, though, would find it hard to compete if their largest rivals were allowed to form a members-only club around essential technologies to which only they had access. Microsoft’s own general counsel countered two weeks ago that Google was invited to join an earlier consortium bid but declined before the Nortel auction. Embarrassing, yes; dispositive, no. If the offer were still open, now that it is clear Google’s principal wireless rivals are all members, things would be different. Indeed, there’s even an opposite problem of antitrust over-inclusiveness where patents and patent pools are concerned. If everyone in an industry shares joint ownership of the same basic inventions, where’s the innovation competition? Google’s defensive purchase of Motorola is a desperate, catch-up move that does not really change this “everyone-but-Android” reality.

Silicon Valley’s patent wars are for good reason not nearly as popular as Bridezillas or So You Think You Can Dance. Yet they are far more important, economically, to Americans addicted today to their smartphones and spending hundreds of dollars monthly on wireless apps and services. Whether the Justice Department will challenge the Rockstar Bidco consortium or give it a free pass remains to be seen. From a legal perspective, it is just a shame the subject is too arcane, and certainly way too dull, to make a reality TV series.

Republished with permission from my op-ed piece at The Huffington Post.