Supreme Court Allows iPhone Owners to Sue Apple for Antitrust Violations

AntitrustThe United States Supreme Court handed a victory to iPhone owners who sued Apple for violating antitrust laws by forcing them to buy apps from its App Store. As are many cases in a divided Supreme Court, the case was decided by a 5-4 vote. The deciding vote came from Justice Kavanaugh, who broke from the Court’s conservative majority by agreeing that sellers can be sued for engaging in anti-competitive behavior that increases prices in the ecommerce marketplace.

Apple’s App Store

Owners of iPhones can purchase applications (apps) for their phones online by using their phones to access an App Store. The App Store comes with the phone and is the only place where an iPhone owner is permitted to buy iPhone apps.

Apple’s user agreement (the fine print that nobody reads) requires iPhone owners to purchase apps only through the App Store. Even without that agreement, an iPhone is designed to install new apps only if they come from the App Store.

Most iPhone apps are developed by independent companies. They pay a small fee to Apple for the right to market their apps in the App Store. They set their own prices, but they must pay Apple a 30% commission on their app sales.

Antitrust Lawsuit

Four iPhone owners sued Apple, contending that the iPhone maker had monopolized the market for apps by requiring them to buy apps from the App Store. They argued that the price of Apple apps is artificially high because developers pass Apple’s commission through to purchasers.

It stands to reason that a developer selling a competing app in a different forum, freed from the requirement to pay 30% of the selling price to Apple, would compete for business by charging less than a developer that sells a similar app in the App Store. The owners who brought suit also contended that Apple would likely reduce its 30% commission if its store had to compete against outside vendors, and that prices in the App Store would thus be lower in a competitive environment.

A federal court dismissed the lawsuit because Supreme Court precedent holds that antitrust laws protect only “direct purchasers” of products. The Ninth Circuit reversed and reinstated the complaint. The Supreme Court agreed to resolve the meaning of “direct purchaser” in the context of apps sold in the App Store.

Direct Purchaser Precedent

The precedent that resulted in the “direct purchaser” limitation on antitrust enforcement involved Illinois Brick Company, which manufactured and sold concrete blocks. Most of the brick company’s customers were masonry contractors who used the blocks to build structures for general contractors. The general contractors sold their services to clients who were the ultimate consumers of the concrete blocks.

The State of Illinois sued Illinois Brick Company, alleging that Illinois Brick conspired to fix the selling price of its concrete blocks. Even though the State of Illinois, as the ultimate consumer, contended that it was harmed by anti-competitive prices that were passed through the supply chain, the Supreme Court held that only “direct purchasers” (generally the masonry contractors who purchased the concrete blocks) could sue Illinois Brick for its unlawful behavior.

The masonry contractors probably passed the higher cost along to general contractors who probably passed it along to consumers, so the masonry contractors had no incentive to sue Illinois Brick. It was the consumers, not the contractors, who lost money. The Supreme Court decision thus prevented the ultimate victims of unlawful anti-competitive behavior from achieving a remedy.

The Supreme Court’s rejection of a pass-through theory of antitrust liability created a loophole that served as a gift to companies that engage in unlawful behavior when the victims of that behavior are not direct purchasers from the company that violates the law. That loophole could be remedied by congressional action, but Congress has apparently been satisfied with the Supreme Court’s resolution of the Illinois Brick case. The question before the Court in the Apple case was whether consumers who buy apps from the App Store are direct purchasers.

Supreme Court Decision

The Court reasoned that iPhone owners “are not consumers at the bottom of a vertical distribution chain who are attempting to sue manufacturers at the top of the chain.” Rather, iPhone owners purchase apps directly from Apple. The only entity the consumers paid was Apple, and the overcharge they allegedly paid benefitted Apple. They were thus entitled to sue Apple as direct purchasers.

Apple argued that consumers purchase apps from companies that sell the apps through the App Store. In its view, Apple merely earns a commission on the sale. The companies set their own prices and, if they choose to “pass through” the cost of Apple’s commission, the Illinois Brick decision prohibits them from suing Apple based on a pass-through theory of liability.

The majority rejected that analysis with the straightforward observation that consumers pay Apple, not the app company, when they buy an app from the App Store. Unlike the customers in Illinois Brick who purchase goods from a general contractor, not from the company that allegedly violated antitrust law, the lawsuit against Apple contends that iPhone owners pay higher prices for apps because they are forced to buy them Apple, the entity that violated the law by engaging in anti-competitive behavior.

What mattered to the majority is not who set the price, but whether the consumer who was harmed by anti-competitive behavior is a direct purchaser from the entity that engaged in the unlawful behavior. The anticompetitive harm to direct purchasers is the same, whether the seller earns profits by marking up the supplier’s price or by charging the supplier a commission. Insulating sellers from the results of their unlawful behavior simply because the seller’s distribution scheme involves commissions rather than markups would encourage anti-competitive behavior by creating another loophole in antitrust law.

While the dissenting justices condemned the majority decision as resurrecting “convoluted” pass-through theories of liability, Justice Kavanagh’s analysis is remarkably straightforward. As he noted in his conclusion, the purpose of antitrust law is to protect consumers from monopoly prices. The Supreme Court refused to give effect to that purpose in its Illinois Brick decision, but declined to expand the loophole it created by shielding Apple for its allegedly anti-competitive behavior.

Impact on Consumers

The Court’s decision reinstates the lawsuit, which probably will not proceed to trial for several years, given the vigor with which Apple will contest it. The court’s decision, however, opens the door to lawsuits against vendors who have adopted Apple’s business model.

Owners of smartphones that use the Android operating system can purchase apps from any vendor. Forcing iPhone owners to purchase apps only from Apple’s App Store may be one explanation for the decline in iPhone sales. Whether the court’s decision will cause Apple to change its business model remains to be seen, but the decision should discourage other tech companies from creating “walled-in” online stores that prevent consumers from purchasing apps and other aftermarket goods from outside vendors.

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