FTC v. Facebook

FTC v. Facebook

This is the second high-profile lawsuit filed by U.S. antitrust authorities within a few months. After the Department of Justice (DoJ) filed a lawsuit against Google at the end of October, the second competition watchdog, the Federal Trade Commission (FTC), is now showing its teeth against Big Tech. On December 9, 2020, it filed a lawsuit against Facebook for violations of competition law. Johannes Persch gives a first overview of the 53-page complaint.

As in the DoJ’s case against Google, the FTC is not acting alone. It has coordinated its action with 48 Attorney Generals, who have simultaneously filed suit in separate proceedings. Only the Attorney Generals of Alabama, Georgia, South Carolina and South Dakota (all Republican) did not join the suit. The core of the accusation against Facebook in both proceedings is that Facebook systematically bought up potential competitors (WhatsApp and Instagram) in order to eliminate competition. In addition, the case also concerns the terms and conditions for third-party software on Facebook.

The nature of the Case (paras 1-29)

The FTC begins with a brief summary of its case: Facebook is the dominant social network with more than three billion users worldwide. However, it has not maintained this position through competition on the merits, but by buying up competitors. The “smoking gun” is already being presented here; Mark Zuckerberg wrote in an e-mail in 2008: “it is better to buy than compete” (para 5).

Then it gives a brief description of the market (paras 6 f.). There are high barriers to entry, mainly due to network effects. This argumentation is now known and widely accepted: A social network only makes sense for the individual user if it is also used by a sufficient number of friends and acquaintances. To be attractive, it therefore needs a critical mass of users. This is difficult for a new competitor to achieve, since practically all potential users are already on Facebook. The FTC, however, is developing the idea further and specifies that it is a question of the respective mechanism of social networking. If there is already a photo sharing channel that is used by a critical mass, it will be difficult for a competitor to succeed with a similar product.

However, the (potential) competitor of the dominant undertaking would have a chance if it exploited technological or social developments and, on this basis, offered a product that differed from that of the dominant undertaking (para 7). In order to eliminate this competitive threat, Facebook purchased Instagram and WhatsApp and restricted access to Facebook for third-party apps in an anti-competitive manner (para 9).

Through these practices, Facebook has illegally maintained its dominant position and thereby harmed competition (paras 27-29). Facebook has created a “protective moat” around its monopoly in the social networking market. It has thus deprived users of the benefits of competition – in particular choice, quality and innovation. The behavior also suppressed serious competition for advertising on social networks.

Has Facebook built a protective moat around its social network?

How does the FTC describe the industry (paras 34-50)?

This is followed by a brief overview of Facebook’s rise as a dominant social network (paras 34-42) and Facebook’s business model (paras 43-50).

The functions of a social network are described: Content can be shared and displayed simultaneously with a large circle of friends (para 40). The users have a wide range of interaction options at their disposal: Sharing, posting, commenting, marking etc. Facebook, which was founded in 2004 by Mark Zuckerberg and his “Harvard College classmates” (para 38), overtook its competitors Friendster and Myspace by 2009 and has since become the most widely used social network worldwide (para 41). Because social networks typically do not charge monetary prices to their users, competition takes place with regard to other factors, including the quality of the user experience, the functionality of the network and privacy options (para 42).

Facebook earns its money through advertising, and this seems to be extremely lucrative: in 2019, Facebook is said to have generated revenues of USD 70 billion (para 44). Based on the user data collected by Facebook, advertisers can select specific user groups to whom their advertising is to be displayed (para 44). The FTC believes that social advertising is different from other types of advertising. This includes not only offline advertising, which obviously lacks targeting accuracy, but also other forms of online display advertising and search engine advertising. The latter advertising is closer to the purchase decision (para 47). This argumentation is already familiar from the DoJ’s Google case. Social advertising should be distinguished from other forms of display advertising because personalized data allows very targeted advertising and advertising can also be displayed in a way to resemble “native” (user generated) social media content (para 48). Anyone who uses Facebook will have already noticed this: At first glance, the advertising in the Facebook feed is often hardly distinguishable from user-generated content.

Which markets are affected (paras 51-60)?

According to the FTC, the market for personal social networks in the USA is affected. The product market differs from other online services by three main characteristics: 1. personal social networks are based on a “social graph”. This connects friends, family and acquaintances and is the basis for communication on the social network (para 53). 2. they allow the sharing of personal experiences in a common social space in a one-to-many broadcast format (para 54) and 3. allow users to connect with each other (para 55). Personal social networks are distinct from other specialized social networks (e.g. LinkedIn). These are only used by a specific group to share a certain type of content (para 58).

The FTC also differentiates the market from other online services that rely more on passive consumption (e.g. YouTube, Spotify, Netflix) than social interaction (para 59). Pure messaging services (e.g. SMS, WhatsApp) differ from social networks in that they only exchange messages based on existing contact information and the communication usually takes place between a small group. Facebook is the digital town square, WhatsApp the digital living room (para 60).

Like the Bundeskartellamt (and the BGH) in its highly regarded Facebook decision, the FTC is thus consistently following the demand-side oriented market concept (“Bedarfsmarktkonzept”). In contrast to the U.S. Supreme Court in Amex, the FTC does not go into detail about the second side of the market (here: advertising customers) when defining the market. However, the significance of two-sidedness regarding Facebook is probably to be assessed differently than in the Amex case, which concerned credit cards. While the credit card customer naturally wants the card to be accepted by as many merchants as possible, the Facebook user has no particular interest in being shown advertising. Positive indirect network effects therefore only exist in the direction of the advertisers (para 67). A market entry can therefore – provided enough financing is available – initially also take place without advertisers, as it has happened with Instagram.

Geographically, a US market is assumed (para 56). Users of social networks in the USA would mainly connect and share content with other users in the USA.

Is Facebook dominant (paras 61-67)?

In the personal social networking market in the USA, as defined by the FTC, there are not many competitors. Facebook’s market share is over 60 % (para 64). This still seems rather low compared to the market shares of 90 – 97 % assumed by the Bundeskartellamt in Germany. However, the 60 % market share is sufficient for a dominant position. Especially considering the barriers to market entry of direct network effects (para 65) and high switching costs (para 66).

What is the behavior at issue (paras 68-160)?

As briefly outlined at the beginning, there are three allegations: 1. the purchase of Instagram, 2. the purchase of WhatsApp, and 3. the conditions of access to application programming interfaces (APIs). Facebook follows the strategy “better to buy than compete”. The API access conditions were also designed to discourage and nip competition in the bud. Thus, Facebook’s anti-competitive intent is at the forefront, as evidenced by numerous internal e-mails between Facebook managers (most notably Mark Zuckerberg himself).

The purchase of Instagram (paras 78-106)

From around 2010, the spread of smartphones has fundamentally changed people’s Internet behavior. Internet was used more and more on smartphones. This created new opportunities for social interaction, especially sharing photos became popular (para 78). Facebook, however, dates back to the era of desktop PCs and was not optimized for mobile use.

Facebook in this regard offered only weak products, especially for sharing photos (para 79). Instagram, on the other hand, specialized in sharing photos using smartphones and was able to fill this gap. The company managed to reach ten million users within one year (para 81). Facebook observed this development with growing panic (“we are getting our ass kicked by Instagram”). Because Facebook’s own photo app (“Facebook Camera”) was still not successfully developed, Facebook finally decided to buy up the unpopular competitor. Facebook paid USD 1 billion for this, which the FTC believes illustrates the perceived competitive threat faced by Facebook (para 95). Facebook’s Instagram competitor went online a few months after the Instagram purchase. However, the app never made the breakthrough, which is why it was discontinued in 2014. If you can’t remember Facebook Camera, this is what it looked like back then.

The purchase of Instagram was not only made out of fear of a stand-alone Instagram, but also out of fear of Instagram in the hands of another buyer (e.g. Google, Apple or Twitter) (para 86). Facebook’s uncompetitive buying motivation is evidenced by a number of internal e-mails. In one of these, Mark Zuckerberg himself explains the strategy (para 91): competitors such as Instagram are to be bought up, but their products will (initially) be kept alive. This would make it difficult for any other competitor with similar networking mechanisms to enter the market because of the network effects. In the long term, the corresponding functions could then be integrated into Facebook’s network.

Without the purchase, users would have benefited from an independent Instagram: Pressure to innovate through stronger competition and competitive control over Facebook and its services (para 105).

The purchase of WhatsApp (paras 107-128)

The accusation here is essentially the same: instead of competing with WhatsApp, Facebook decided to buy the competitor. WhatsApp could have been dangerous to Facebook by adding social networking features to the messaging service or by entering Facebook’s core market with a standalone product (para 108). Again, the FTC has documented Facebook’s anti-competitive intent with several emails. As with Instagram, Facebook initially attempted to compete with WhatsApp with its own app (Facebook Messenger, which still exists today) (para 115).

However, Facebook was not able to stop the steady growth of WhatsApp. As with Instagram, the decision was made to buy – also in order to avoid a possible acquisition by Google. The smoking gun here is an e-mail from Mark Zuckerberg:

“[I]’m the most worried about messaging. WhatsApp is already ahead of us in messaging in the same way Instagram was “ahead” of us in photos. […] I’d pay $1b for them if we could get them.” (para 120)

In fact, Facebook had to reach even deeper into the pocket: in 2014, it bought WhatsApp for USD 19 billion (para 121). As a result, Facebook naturally did not take any steps to transform WhatsApp into a social network but continued to operate the app essentially without any new developments (para 126).

As with the purchase of Instagram, the advantage of a (potential) competitor had been taken away from the users. WhatsApp’s stronger focus on data protection would have offered potential to offer a differentiated and competitive product to Facebook (para 127). The assumption that competition can lead to greater data protection has already been raised in the proceedings against Google and now appears to be gaining ground in the USA.

Facebook paid USD 19 billion for WhatsApp.

Access to APIs (paras 129-160)

The lawsuit becomes a little more technical when it comes to the accusation that Facebook has only granted access to its APIs under anti-competitive conditions. Since 2010, Facebook has allowed third party apps to access certain APIs. These include the “Find Friends API”, for example. With the help of this function, another app can, for example, ask its users to connect with Facebook friends in this app as well or invite them to use the app (para 130). Apps and websites can also use the “Open Graph API” to install certain Facebook plugins, especially the Facebook “Like” button. When the Facebook user clicks on this button, the app or website is automatically shared in their network via Facebook – a good opportunity for the third-party app to attract new users (para 131). Facebook has become an important infrastructure for third-party apps (para 135). It has used the power that comes with this to suppress competitive threats (para 136). In particular, API access between 2011 and 2018 was granted only on condition that the third-party app did not compete with Facebook (i.e. did not offer core Facebook functions) and did not promote competitors (para 136). Thus, if Instagram had not already been purchased by Facebook, Facebook would presumaby have denied it any access to the APIs. These practices have deterred software developers from creating any features that could compete with Facebook (para 137). While the announcement of Google+ originally gave rise to these business practices (para 140), later on, the social network “Path” (para 153), the apps “Circle”, a local social network (para 154), and “Vine”, a video-sharing app operated by Twitter (para 155), were affected. In addition, all mobile messaging apps were denied access (para 156). Those who have not yet heard of Path, Vine and Circle should not be surprised. All three apps were shut down after a few years of operation.

Once again, the FTC argues that the practice has restricted competition. Promising competitors have been deterred and Facebook has thus been able to maintain its monopoly (para 159).

The FTC does not address the allegation by the Bundeskartellamt that Facebook also collects additional user data by integrating functions on third-party websites and apps.

What is the competitive harm (paras 161-168)?

According to the FTC, the competitive harm is that users of social networks have been deprived of the benefits of competition (para 162). This rather sweeping and somewhat circular-looking assertion is further elaborated: Additional competition would have brought more innovation (e.g. new features and business models for social networks), better quality (e.g. improved features) and more choice for consumers (e.g. with regard to data protection) (para 163). Advertising customers have also been deprived of the benefit of effective competition (paras 164-167). The core idea is that without Facebook’s purchasing strategy, WhatsApp and Instagram would have become serious competitors or, with different access conditions to Facebook’s APIs, other competitors could have developed.

Will Facebook be broken up?

In contrast to the DoJ’s proceedings against Google, the FTC proposes concrete remedies. And this is where it gets the big stick: it demands the divestiture of Facebook, in particular the splitting off of WhatsApp and Instagram. In addition, Facebook should have all future mergers and acquisitions approved. Of course, it is not yet certain whether the divestiture will take place. Unlike in the Google case, however, the question is no longer just unspoken, but divestiture now is officially demanded by a competition authority. In this way, the USA is putting itself at the forefront of efforts to gain control over big tech with anti-trust law. So far, these efforts have been led primarily by the EU and dismissed by the US as protectionist policies. The United States is apparently also trying to learn from the proceedings conducted in the EU: Although record penalties have been imposed, little has changed in the competitive situation. Whether the threat of divestiture is more effective will remain to be seen. It is of course also possible that other remedies will be chosen during the proceedings. In the case of the FTC’s accusations, however, the “internal unbundling” demanded by the Bundeskartellamt, for example, does not appear to be effective. According to this, Facebook must process the data from WhatsApp, Instagram and Facebook separately and not merge them. However, this will hardly prompt Facebook to develop WhatsApp or Instagram as competitors of Facebook with innovative social networking features.

What does Facebook say?

As was to be expected, Facebook sees things differently. In a statement, Jennifer Newstead (Vice President and General Counsel) describes the lawsuit as “revisionist history”. She argues that Facebook competes for the “time and attention” of users with many other services, including Google, Twitter, Snap, Amazon, TikTok and Microsoft. This suggests that Facebook is attacking the FTC’s market definition. Facebook defends its acquisitions, after all, both have been approved by the FTC itself. The acquisition of Instagram even in a “second request” process. This is roughly equivalent to a Phase II review. The EU Commission has also approved the WhatsApp transaction. Now, the FTC wants to reverse these mergers without regard to the “consequences for innovation and investment”. In the meantime, Facebook has invested billions in WhatsApp and Instagram. The FTC’s decision to initiate proceedings now would mean that no purchase is ever final and would destroy any legal certainty. The two acquisitions were anything but anti-competitive. For example, it was only through Facebook’s investments that Instagram developed into the network with over one billion users that it is today. Advertising customers have also benefited from Facebook’s investments. WhatsApp also only spread in the USA through Facebook’s investments. In particular, Facebook had abolished the user fee existing at the time of purchase and made the app available free of charge. However, the latter is not a particularly strong argument; after all, the FTC also argues that Facebook has hindered competition for innovative business models. WhatsApp could have become a paid alternative to the “free-of-charge culture” on the Internet. By relying on other factors, particularly privacy, it could have become a serious alternative to Facebook and its business model.

In terms of API access, Facebook considers its practice to be the industry standard. Other companies, such as LinkedIn, The New York Times, Pinterest or Uber, would have similar terms and conditions. Companies would be free to choose their business partners.

Facebook also links the case to the general mood on “big tech” and issues such as influence on elections and data protection. However, it argues, none of these are questions of antitrust law and must therefore be dealt with by new rules for the Internet.

Would a divestiture in Europe be possible?

In the EU and in Germany, unbundling outside of merger control (keyword gunjumping) is not (yet) explicitly regulated. According to the case law of the ECJ in Continental Can, in principle this would already be possible. The European Commission’s proposal for the Digital Markets Act, which was presented a few days ago, now expressly contains the power to take structural remedies (Art. 16). This involves the “legal, functional or structural separation, including the sale of a business, or parts of it” (see recital 64). This makes it more likely that digital gatekeepers will be broken up in Europe in the future.

What happens next?

The filing of the lawsuit was just the prelude to what will in all probability be years of proceedings. It shows that the power of big tech companies is taken seriously on the other side of the Atlantic. If Facebook were to be unbundled and WhatsApp and Instagram, whose purchase was previously approved by the FTC, were to be split off, this would be a landmark case.

The FTC’s case against Facebook could be a milestone in the evolution of antitrust law in the digital age. The accusations often made in the USA in the past that the EU is only targeting GAFA for protectionist reasons will finally be invalidated. Moreover, the proceedings show that the term “killer acquisitions”, which is so often used, does not adequately describe the problem. Potential competitors are not bought up by big tech companies in order to eliminate them. Instead, they are kept alive, but their functionalities are not developed further, thus keeping them out of the core business and making it difficult for other competitors to enter.

The question of access to programming interfaces will also be of great importance in the future. Although the Commission’s proposal for the Digital Markets Act explicitly mentions access to APIs only for the purpose of data portability (see recitals 54 and 55), it contains some other provisions that at least go in this direction. For example, gatekeepers must enable access and interoperability if they also do so with respect to their own “ancillary services” (Art. 6 No. 1 lit. f).

The FTC’s action is likely to be closely watched in Europe. A competition between competition authorities seems to have begun as to who can get a better grip on big tech.

Johannes Persch, LL.M. (Chicago) is a research assistant at the Chair of Civil Law, German and European Business and Employment Law (Professor Kainer) at the University of Mannheim and doctoral fellow of the Studienstiftung des deutschen Volkes.

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