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The
Internet is a revolutionary means of communications and commerce that can
dramatically enhance consumer sovereignty and empower citizens, but only if
public policy keeps it open. A
decade and a-half of experience in Internet and software policy reaffirms our
belief that consumers and the economy are best served by open standards and
networks. These afford the
consumer maximum choice and the citizen maximum voice.
They stimulate audacious competition, encourage use and expression, and
promote unfettered innovation and experimentation by both consumers and
producers.
This
hearing highlights a very familiar old economy problem with very real
implications for the new economy of the Internet. Traditional commercial restraints on trade can rob consumers
of the benefits of the Internet, just as surely as do closed proprietary
networks, incompatible operating systems, or balkanized applications.
Classic restraints on trade, unilateral or collusive, can limit the
availability of products, restrain price competition, or negate the beneficial
effects of the Internet in enhancing consumer search capabilities.
We must be vigilant to prevent dirty old business practices from
migrating into cyberspace, if we are to preserve the procompetitive,
consumer-friendly promise of the Internet.
The
ability to gather and process information that is greatly facilitated by the
Internet is a two edged sword. It
can strengthen the ability of producers to control and manipulate the markets,
just as easily as it can enhance the ability of consumers to shop and open
distribution channels that increase competition.
To
demonstrate how important this issue is, I briefly discuss two very different
examples. The first involves
highly perishable, low costs services – cheap seats on airplanes.
The second involves very durable, expensive products – new
automobiles.
CHEAP SEATS
The
growth of online discounters offering cheap seats – from Price Line to
Travelocity – poses a threat to the oligopolistic structure of the airline
industry, at least in the distribution part of the business.
Acting independently, the airlines cannot resist making seats available
at a low, “name your own price” level.
A massive cyber-auction increases the likelihood of their being sold
and allows supply to meet demand in a more efficient manner.
Only the Internet (or an equally ubiquitous. accessible information
environment) could bring this immense real time market into existence on a
massive scale for consumers to directly choose what to buy in the way of
discount tickets.
The
side effects were not to the liking of the airlines collectively, however.
If people think they can name their own price or shop for bargains,
price resistance grows on the demand-side.
When these tickets pop up in the chaos of cyberspace, uncertainty is
created on the supply-side. It is
more difficult for airlines to know how many seats are being offered at what
prices with this sort of arrangement. It
is easy to make secret deals with the discounters to fill your planes at the
expense of rivals. In an
oligopolistic industry that has developed the most precise mechanisms of price
discrimination in memory and an intricate systems of fortress hubs to exercise
market power over increasingly captive traffic, this web-based discounting
sound suspiciously like competition.
The
response by the industry as a whole is to try to control this unruly behavior.
By organizing their own online broker over which they have greater
control, they may still sell many of the seats, but eliminate the price
disciplining effect of unaffiliated discounters.
At a minimum, they could reduce the supply of discount seats the
discounter can offer. Depending on how industry-owned site is organized, the
airlines can guarantee a reduction in supply of discounted seats by requiring
members to make seats available. Airlines
may have better information about the availability and price of seats when
they control their own site. They
may also have rules – formal, or more likely informal – about making seats
available on multiple sites. Reducing
the discounters’ ability to make the “name your own price” promise, or
even the lowest price available claim, will eventually degrade their ability
to discipline price. In our view,
Orbitz suffers from all these defects.
EXPENSIVE PRODUCTS
State
laws that prohibit or impair direct sale of automobiles over the Internet are
a more blunt and equally anticompetitive roadblock on the information super
highway. Not only is it
illegal to sell a new car over the Internet in virtually all states, it is
even illegal for manufacturers to distribute the hits on their home pages to
the best dealers in the consumers’ area in some states, or to sell
comparison-shopping information to the public.
As
the capability to deliver information expands and access to multimedia,
interactive information applications improves, an environment in which
producers and consumers can interact directly for automobiles could be
created, just as it was for the “name your own price tickets.”
Tens of billions of dollars could be saved as a result of more
effective shopping by consumers, better targeting of marketing efforts,
personalized design of products, and reduced inventory/holding times for the
delivery of goods.
Higher
and higher quality visual and video images that can be tailored and modified
during the transaction, promise a quantum leap in the quality of marketing and
consumer information gathering. Increasing
integration of production with consumer preferences identified through on-line
transactions can both dramatically reduce marketing and inventory costs and
increase customer satisfaction. Personalized selling and flexible production can combine with
interactive scheduling to reduce the amount of time that goods must be held in
storage or spend in transit, sharply reducing delivered costs on big ticket
items like automobiles.
We
would get rid of the build-to-inventory system of the 20th century
that causes new cars to sit on lots for two or three months.
A 21st century build-to-order system would put exactly the
car the consumer wants in the driveway in two or three weeks because the
ubiquitous information network empowers consumers and allows supply to match
demand. The savings for consumers
and the economy would run to tens of billions a year.
But, this would dramatically reduce the role of the dealers as
middlemen. The acres and acres of
inventory by which they defined their very being would be irrelevant and
uneconomic.
The
Internet is a disruptive technology. Entrenched
interests will seek to preserve their market niches and market power, no
matter how high a cost that imposes on the public.
I applaud you for holding these hearings that highlight this important
but overlooked aspect of public policy for the Internet.
Mr. Chairman and Members of
the Committee,
My name is Dr. Mark Cooper. I am Director of Research of the Consumer Federation of
America. The Consumer Federation of
America (CFA) is the nation's largest consumer advocacy group, composed of two
hundred and eighty state and local affiliates representing consumer, senior,
citizen, low-income, labor, farm, public power and cooperative organizations,
with more than fifty million individual members. CFA is online at www.consumerfed.org.
I appreciate the opportunity
to appear before you today to share our thoughts on the potential
anticompetitive effects of joint ventures and other producer restraints on trade
on the Internet. The Consumer
Federation of America, founded over 30 years ago, was one of the first consumer
groups to become involved in public policy affecting high-tech,
consumer-oriented industries.
The Internet is a
revolutionary means of communications and commerce that can dramatically enhance
consumer sovereignty and empower citizens, but only if public policy keeps it
open. A decade and a-half of experience in Internet and software
industry policy reaffirms our belief that consumers and the economy are best
served by open standards and networks. These
afford the consumer maximum choice and the citizen maximum voice, stimulate
audacious competition, encourage use and expression, and promote unfettered
innovation by both consumers and producers.
A
TECHNICAL AND CONSUMER POLICY MAP OF CYBERSPACE
I believe that the Internet
can best be understood by seeing it as a communications platform consisting of
four layers – the physical layer, the logic layer, the applications layer and
the content layer. It is a platform
because the layers are strong complements; they need to be tightly integrated
and coordinated. In each layer
there are “digital economy “ issues that stem from its unique
characteristics.
We hear a great deal about
the physical layer, which is the medium over which Internet messages are
transmitted. In this layer the
primary concern is with owners of facilities – like cable operators and
telephone companies – who refuse to allow service to have nondiscriminatory
access to their telecommunications networks.
We hear a great deal about
the logic layer, which is where code and protocols allow communications
equipment, computers and display devices to interconnect and interoperate.
In this layer the concern is with dominant software firms – like
Microsoft – who can undermine the compatibility of competing code and lock out
competition.
We hear a lot about the
applications layer, where programs execute a sequence of steps to solve a
problem or perform a task for the user. Here
the concern is with applications –
like instant messaging or identity verification – that refuse to interoperate,
undermining universal availability and creating walls in cyberspace.
The issue before the
Committee today deals with the content layer – the specific products or
services delivered through the platform – but it is not the usual content
debate we hear about. We frequently
hear about this layer as a debate over digital content – digital rights
management demands by content owners, on one side, who treat all consumers as
thieves and want to hardwire antitheft devices into the fabric of cyberspace,
and consumers on the other side, who demand fair use rights to enjoy the content
they purchase when, where and how they desire.
The issue the Committee
raises today is different.
OLD
ECONOMY PROBLEMS MIGRATING INTO CYBERSPACE
This hearing highlights a
very familiar old economy problem with very real implications for the new
economy of the Internet. Traditional
commercial restraints on trade can rob consumers of the benefits of the
Internet, just as surely as do closed proprietary networks, incompatible
operating systems, or balkanized applications.
Classic restraints on trade, unilateral or collusive, can limit the
availability of products, restrain price competition, or negate the beneficial
effects of the Internet in enhancing consumer search.
The ability to gather and
process information that is greatly facilitated by the Internet is a two edged
sword. It can strengthen the
ability of producers to control and manipulate the markets, just as easily as it
can enhance the ability of consumers to shop and open distribution channels that
increase competition.
This hearing makes it clear
that we must be vigilant to prevent plain old dirty business practices from
migrating into cyberspace, if we are to preserve the procompetitive,
consumer-friendly promise of the Internet.
To demonstrate how important this view of the content layer is, I will
make the point with reference to two very different examples.
The first involves highly perishable, low costs services – cheap seats
on airplanes. The second involves
very durable, expensive products – new automobiles.
CHEAP
SEATS
A couple of years ago, the
airlines showed a willingness to make low value, high margin seats available to
online discounters. These are low
value seats in the sense that they involve unsold seats close to the time of
departure. They are like overripe
fruit on the grocery shelf that cannot be sold at full price.
Since the incremental cost of that unsold seat is virtually zero, any
incremental revenue is pure profit.
Acting independently, the
airlines cannot resist making them available at a low, “name your own price”
level. The information exchange about these tickets in a cyber
auction increases the likelihood of their being sold and allows supply to meet
demand in a more efficient manner. Only
the Internet (or an equally ubiquitous. accessible information environment)
could bring this immense real time market into existence on a massive scale for
consumers to directly choose what to buy in the way of discount tickets.
The side effects were not to
the liking of the airlines collectively, however.
As long as William Shatner was able to make people think they could name
their own price, he was creating price resistance on the demand-side. As long as these tickets pop up in the chaos of this
new cyberspace type of auction, he creates uncertainty on the supply-side.
It is more difficult for airlines to know how many seats are being
offered at what prices with this sort of arrangement.
It is easy to make secret deals with the discounters to fill your planes
at the expense of rivals. In an
oligopolistic industry that has developed the most precise mechanisms of price
discrimination in memory and an intricate systems of fortress hubs to exercise
market power over increasingly captive traffic, this web-based discounting sound
suspiciously like competition.
The response by the industry
as a whole is to try to control this unruly behavior.
By organizing their own online broker over which they have greater
control, they may still sell many of the seats, but eliminate the price
disciplining effect of unaffiliated discounters.
At a minimum, they could reduce the supply of discount seats the
discounter can offer. Diminishing
their ability to make the “name your own price” promise, or even the lowest
price available claim, will eventually degrade their ability to discipline
price.
Depending on how they
organize the site, the airlines can guarantee a reduction in supply of
discounted seats by requiring members to make seats available.
Airlines may have better information about the availability and price of
seats when they control their own site.
They may also have rules –
formal, or more likely informal – about making seats available on multiple
sites.
I use the “name your own
price” model as an example, because it exploits the information environment
most intensively and has the cheapest seats.
Orbitz may not be directly targeted at it, but it is certainly targeted
at the next tier of cheap seats that are offered by Travelocity, Expedia and
travel agents and it certainly has an effect on all discounters.
Obviously, we are skeptical
of the proconsumer intent and impact of this sort of coordinated industry
activity, especially when an independent undertaking came first.
In more general terms, these types of producer joint ventures raise the
fundamental problems of horizontal concentration and vertical integration
disguised as consumer friendly e-commerce applications.
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Every
time firms that are supposed to compete in the marketplaces have a meeting
in cyberspace or physical space, it enhances the chances of collusion.
-
Every
time firms exchange information about input prices or the price and quality
mix of their product line, they can increase the likelihood of
anticompetitive parallelism.
-
Every
time they create ventures that diminish the availability of inputs, they may
raise barriers to entry for potential competitors and raise the costs of the
actual rivals.
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Every
time they create ventures that coordinate their sales to the public, they
reduce the likelihood that independent action will lower prices.
In other words, the
efficiency that these ventures promise by lowering input costs is only in the
public interest if it does not have any of these anticompetitive side effects.
Of course, the industry insists this is not the purpose, nor would it
engage in such activity, but it is the job of the antitrust and consumer
protection agencies to prevent the anticompetitive outcomes.
The problem could be massive in cyberspace and the ability of enforcement
authorities to detect and prevent it is limited.
As the chances of being caught are diminished, the likelihood of the
violation increases.
One possibility is to have a
huge increase in the funding for the regulatory agencies charged with policing
this type of potentially anticompetitive activity.
There is little chance that will happen. In the alternative, we need
clear measures to prevent anticompetitive arrangements before they are executed.
An ounce of prevention is worth a pound of cure.
The antitrust authorities are familiar with such mechanisms.
A rule of reason should apply with heightened scrutiny and consent
decrees that ban specific practices.
Market
Share thresholds: Arrangements that
account for a significant share of the suppliers in a market should be subject
to specific investigation.
Ownership
Matters: Profit sharing between firms
should be discouraged, since this diminishes the incentive to compete.
Firms should not generally appear on both sides of a transaction, since
this aids in the manipulation of the availability of a product or its price.
Restriction
of supply: Restriction of supply
either by requiring certain quantities to be offered or preventing participants
from selling outside of the arrangement at attractive prices may restrict supply
to the market and have the effect of undermining rivals or reducing competition
for consumers. Such arrangements
should not be allowed.
Participation
Rules: If the ventures that invite the
public to participate as buyers or sellers, then rules about who can make
product available to or purchase product from the venture should not be unduly
discriminatory or exclusionary.
Information
exchange: Joint venture
participants should not gain access to information on competitors’ costs (of
inputs) or quantities and prices of output sold through the venture.
This requires anonymous transactions executed by a site administrator.
Oversight of informal behavior and
compliance with conditions: Joint
venture operations provide significant opportunity for exchange of competitively
sensitive information in informal ways. These joint ventures should be required to have an Ombudsman
to be present at all official functions and to monitor operations.
A finding by the Ombudsman that anticompetitive activity has occurred
should become a rebuttable presumption of a violation of the antitrust law.
EXPENSIVE
PRODUCTS
At the start of what has been
called the “Internet Century,” there can be no better symbol of the
transformation of the economy than a battle over automobile sales on the
Internet. The automobile is not only the quintessential symbol of the
industrial economy of the twentieth century; it is also the second largest
expense on a consumer durable that most households make.
Moreover, the distribution network that typifies the industry has
important and unique elements that make it a potentially intense battleground
when the new economy meets the old. The
automobile is an expensive, long-lived commodity that requires post-purchase
maintenance. Historically, this created a unique relationship between the
dealer and the consumer. The
dealerships have traditionally involved substantial investment.
Automobile dealers are the quintessential old economy middlemen.
Some believed that these
unique characteristics would prevent or slow Internet-based transactions from
penetrating the distribution chain. The
automobile was believed to be a type of commodity that is not well suited to
Internet sales. Cars were not
considered a good candidate because consumers needed to “kick the tires”
before buying a car.
In fact it was not consumers
who resisted the Internet when it comes to new auto sales.
Consumers are perfectly willing to turn to the Internet for information
about autos and tell the salesman exactly what they want based on online
research. They would probably buy
direct over the Internet, without going to a show room in many cases, if they
could. Unfortunately, they have not
been able to test this distribution chain because state laws protecting dealers
will not let them. Direct sales
over the Internet are illegal in virtually all states.
The cost of distribution of
new automobiles approaches $100 billion per year.
The distribution chain is ripe with inefficiencies and local monopolies
that are perpetuated by state laws. Instead
of the build-to-inventory system of the 20th century, which causes
new cars to sit on lots for two or three months, a 21st century
build-to-order system could get exactly the car the consumer wants into his or
her driveway in two or three weeks. The
savings for consumers and the economy would be immense.
But this would dramatically reduce the role of the dealers as middlemen.
The acres and acres of inventory by which they defined their very being
would be irrelevant and uneconomic.
As the capability to deliver
information expands and access to multimedia, interactive information
applications improves, an environment in which producers and consumers can
interact directly for automobiles could be created, just as it was for the
“name your own price tickets.” These
changes would result in more effective shopping by consumers, better targeting
of marketing efforts, personalized design of products, and reduced
inventory/holding times for the delivery of goods.
-
Higher
and higher quality visual and video images that can be tailored and modified
during the transaction, promise a quantum leap in the quality of marketing
and consumer information gathering.
-
Increasing
integration of production with consumer preferences identified through
on-line transactions can both dramatically reduce marketing and inventory
costs and increase customer satisfaction.
-
Personalized
selling and flexible production can combine with interactive scheduling to
reduce the amount of time that goods must be held in storage or spend in
transit, sharply reducing delivered costs on big ticket items like
automobiles.
To achieve these potential
gains, however, major institutional changes must come about.
Not only is it illegal to sell a car on the Internet, it is even illegal
for manufacturers to distribute the hits on their home pages to the best dealers
in the consumers’ area. In some
states it is illegal to sell comparison-shopping information to the public.
These anticompetitive barriers to use of the Internet may be costing
consumers $20 to $40 billion in the cost of new autos.
Moreover, once the sale of autos is pulled out of the showroom and put
into the competitive context of the Internet, financing, warranty work, and
after market services would become much more competitive, potentially saving
consumers tens of billions of dollars more.
Congress was quick to prevent
the states from taxing the Internet, but much more harm is being done to
consumers by these anticompetitive statutes that prevent them from utilizing the
Internet for full effect. Congress
needs to require states to allow the direct sale of cars over the Internet.
CONCLUSION
These two examples from the
opposite ends of the spectrum of consumer goods and services that could be sold
over the Internet remind us how vigilant we must be if we are to ensure that the
Internet continues to operate in a procompetitive, consumer-friendly fashion.
The Internet is a disruptive technology and entrenched interests will
seek to preserve their market niches and market power, no matter how high a cost
that imposes on the public. I
applaud you for holding these hearings that highlight this important but
overlooked aspect of public policy for the Internet.
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