IN THE UNITED STATES COURT OF APPEALS

USCA Case #15-1018
Document #1550628
Filed: 05/04/2015
Oral Argument Has Not Been Scheduled
_____________________
No. 15-1018
_____________________
IN THE UNITED STATES COURT OF APPEALS
FOR THE DISTRICT OF COLUMBIA CIRCUIT
_____________________
UNITED STATES POSTAL SERVICE,
Petitioner,
v.
POSTAL REGULATORY COMMISSION,
Respondent,
GAMEFLY, INC., and NETFLIX, INC.,
Intervenors for Respondent.
_____________________
On Petition for Review of Order No. 2306,
Docket Nos. MC2013-57 & CP2013-75,
of the Postal Regulatory Commission
_____________________
BRIEF OF THE UNITED STATES POSTAL SERVICE
_____________________
THOMAS J. MARSHALL
Executive Vice President &
General Counsel
R. ANDREW GERMAN
Managing Counsel
DAVID C. BELT*
Office of the General Counsel
United States Postal Service
475 L’Enfant Plaza, SW
Washington, DC 20260
(202) 268-2945
Attorneys for the United States Postal Service
FINAL BRIEF:
MAY 4, 2015
*Counsel of Record
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CERTIFICATE AS TO PARTIES,
RULINGS AND RELATED CASES
A.
Parties, Intervenors and Amici
Petitioner in this matter is the United States Postal Service. Respondent in this
matter is the Postal Regulatory Commission (“Commission”).
This is a petition for review of a final order, issued on December 23, 2014, of the
Postal Regulatory Commission in PRC Docket Nos. MC2013-57 and CP2013-75. In
addition to the Postal Service and a Public Representative appointed by the
Commission, five entities – GameFly, Inc. (“GameFly”); Netflix, Inc. (“Netflix”);
Federal Express Corporation; MMAVault, Inc.; and CafeDVD – participated in the
proceedings before the Commission. Those five entities filed comments but did not
seek to intervene in the proceedings. GameFly and Netflix, two of the entities that filed
comments in the Commission’s dockets, have intervened in the review proceeding in
this Court.
No other entities sought to participate as intervenors or amici curiae in this
petition for review.
B.
Rulings Under Review
The United States Postal Service seeks review of Order Number 2306, Order
Denying Request, dated December 23, 2014, in PRC Docket Numbers MC2013-57 and
CP2013-75. Order Number 2306 is located in the Joint Appendix (“JA”) at pages
JA557 through JA622.
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Related Cases
This matter has not previously been before this Court or any other court.
However, the matter is an outgrowth of an earlier proceeding before the Commission in
PRC Docket No. C2009-1, which culminated in two review proceedings in this Court:
GameFly, Inc. v. Postal Regulatory Commission, 704 F.3d 145 (D.C. Cir. 2013), and
United States Postal Service v. Postal Regulatory Commission, 747 F.3d 906 (D.C. Cir.
2014).
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TABLE OF CONTENTS
Certificate as to Parties, Rulings and Related Cases ..................................................i
Table of Authorities ..................................................................................................vi
Glossary......................................................................................................................x
Jurisdictional Statement .............................................................................................1
Statement of the Issues...............................................................................................1
Statement Concerning Pertinent Statutory Provisions............................................... 3
Statement of the Case.................................................................................................3
Statement of the Facts ................................................................................................5
A. “Market-Dominant” and “Competitive” Products under Title 39 .............. 5
B. Netflix’s and GameFly’s “DVD-By-Mail” Service and Other
Methods of Providing Access to Digital Entertainment Content. .............. 7
C. Previous Proceedings in the Commission and This Court’s
GameFly I and GameFly II Decisions. .....................................................13
D. Instant Proceedings Before the Commission. ...........................................16
E. The Commission’s Final Order. ................................................................17
Summary of the Argument.......................................................................................20
Standing....................................................................................................................24
Argument..................................................................................................................25
I. STANDARD OF REVIEW. ...............................................................................25
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II. THE COMMISSION ERRED IN DEFINING THE RELEVANT
PRODUCT MARKET AS BEING LIMITED TO ENTERTAINMENT
CONTENT THAT IS DISTRIBUTED BY MAIL.. ..........................................27
A. The Proposition that the Mere Availability of Alternative Delivery
Channels Does Not Prove that They Are “Reasonable Substitutes”
for DVD-By-Mail Service is Beside the Point.. ......................................29
B. The Commission’s Analysis of the Differing Inventories Among
Content Providers Does Not Support a Conclusion that Such
Companies Compete In Different Markets..............................................32
1. Products Can, And Do, Compete in the Same Market Despite
Not Having Literally Identical Content..........................................33
2. The Commission’s Analysis of “Limitations” Preventing
Other Firms From Offering Identical Content is Limited and
Flawed. ...........................................................................................37
C. The Commission’s Finding That a “Core Group” of Customers
Prefer DVD-By-Mail Service Does Not Justify Its Conclusion that
DVD-By-Mail Service is in a Separate Product Market. ........................42
D. The Commission’s Discussion of the Views of Industry
Participants Does Not Actually Discuss the Industry Participants’
Views on Who Their Competitors Are. ...................................................49
III. EVEN IF THE COMMISSION’S MARKET DEFINITION WERE
NOT ERRONEOUS, IT STILL ERRED IN ASSESSING WHETHER
THE POSTAL SERVICE HAD “MARKET POWER” WITHIN THE
MEANING OF 39 U.S.C. § 3642(b)(1)... ........................................................53
A. The Commission’s Three Findings Shed Little Light on Whether
the Postal Service Has Market Power Over DVD-By-Mail Service....... 54
B. The Commission Arbitrarily Ignored Factors Bearing on Whether
the Postal Service Has Sufficient “Market Power.”. ...............................56
Conclusion ...............................................................................................................60
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Certificate of Compliance ........................................................................................61
Certificate of Service ...............................................................................................62
Statutory Addendum ................................................................................................63
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TABLE OF AUTHORITIES
CASES
Am. Fed’n of Gov’t Employees v. FLRA, 470 F.3d 375 (D.C. Cir.
2006) ..................................................................................................................26
Ass’n of Am. R.Rs. v. Dep’t of Transp., 38 F.3d 582 (D.C. Cir. 1994)....................24
Ass’n of Civ. Technicians v. FLRA, 250 F.3d 778 (D.C. Cir. 2001) .......................25
Ass’n of Data Processing Serv. Orgs. v. Bd. of Governors of the Fed.
Reserve Sys., 745 F.2d 677 (D.C. Cir. 1984) ......................................................26
Barq's Inc. v. Barq's Beverages, Inc., 677 F. Supp. 449 (E.D. La.
1987) ...................................................................................................................35
Brokerage Concepts, Inc. v. U.S. Healthcare, Inc., 140 F.3d 494
(3d Cir. 1998) ......................................................................................................46
Brown Shoe Co. v. U.S., 370 U.S. 294 (1962) ...................................................18, 43
Catawba Cty., N.C. v. EPA, 571 F.3d 20 (D.C. Cir. 2009) .....................................25
Chevron, U.S.A., Inc. v. Natural Resources Def. Council, Inc.,
467 U.S. 837 (1984) ............................................................................................25
Dep’t of Treasury v. FLRA, 837 F.2d 1163 (D.C. Cir. 1988) ..................................25
Eastman Kodak v. Image Tech. Servs., 504 U.S. 451 (1992) ..................................36
*FTC v. Whole Foods Market, Inc., 548 F.3d 1028 (D.C. Cir. 2008)...............47, 48
GameFly, Inc. v. Postal Regulatory Comm’n, 704 F.3d 145 (D.C. Cir.
2013) ........................................................................................................ ii, 13, 15
Grappone, Inc. v. Subaru of N.E., Inc., 858 F.2d 792 (1st Cir. 1988)...............45, 46
*Authorities upon which we chiefly rely are marked with asterisks.
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Green Cty. Food Market, Inc. v. Bottling Group, LLC, 371 F.3d 1275
(10th Cir. 2004) ...................................................................................................35
In re Brand Name Prescription Drugs Antitrust Litig., 123 F.3d 599
(7th Cir. 1997) .....................................................................................................47
In re Wireless Tel. Servs. Antitrust Litig., 385 F. Supp. 2d 403
(S.D.N.Y. 2005) ..................................................................................................55
Int’l Bhd. of Elec. Workers v. ICC, 862 F.2d 330 (D.C. Cir. 1988) ........................24
Levitch v. Columbia Broadcasting Sys., Inc., 495 F. Supp. 649
(S.D.N.Y. 1980), aff’d, 697 F.2d 495 (2d Cir. 1983) ...................................28, 35
Mfrs. Ry. Co. v. Surface Transp. Bd., 676 F.3d 1094 (D.C. Cir. 2012) .................. 26
Menasha Corp. v. News America Marketing In-Store, Inc. 354 F.3d
661 (7th Cir. 2004) ........................................................................................39, 46
Neumann v. Reinforced Earth Co., 786 F.2d 424 (D.C. Cir. 1986) ........................44
PSKS, Inc. v. Leegin Creative Leather Prods., 615 F.3d 412 (5th Cir.
2010) ...................................................................................................................36
Queen City Pizza, Inc. v. Domino’s Pizza, Inc., 124 F.3d 430 (3d Cir.
1997) ...................................................................................................................44
TV Communications Network, Inc. v. Turner Network Television, Inc.,
964 F.2d 1022 (10th Cir. 1992) ..........................................................................36
United Parcel Serv., Inc. v. U.S. Postal Serv., 184 F.3d 827 (D.C. Cir.
1999) .....................................................................................................................5
U.S. v. Continental Can Co., 378 U.S. 441 (1964) ......................................33, 36, 50
U.S. v. Eastman Kodak Co., 63 F.3d 95 (2d Cir. 1995)...........................................55
U.S. v. E.I. duPont de Nemours & Co., 351 U.S. 377 (1956)......................27, 33, 34
U.S. v. Grinnell Corp., 384 U.S. 563 (1966) ...........................................................43
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U.S. v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001) ...........................................59
U.S. Postal Serv. v. Postal Regulatory Comm’n, 747 F.3d 906
(D.C. Cir. 2014) ................................................................................. ii, 13, 15, 39
STATUTES
5 U.S.C. § 706 ..........................................................................................................26
5 U.S.C. § 706(2) .....................................................................................................26
17 U.S.C. § 109 ........................................................................................................40
39 U.S.C. § 102(8) .....................................................................................................6
39 U.S.C. § 102(9) .....................................................................................................6
39 U.S.C. § 201 ..........................................................................................................5
39 U.S.C. § 403(c) ...................................................................................................14
39 U.S.C. § 3621 (2005) ............................................................................................5
39 U.S.C. § 3621(a) ...................................................................................................6
39 U.S.C. § 3622(d)(1)...............................................................................................6
39 U.S.C. § 3631(a) ...................................................................................................6
39 U.S.C. § 3633 ........................................................................................................6
39 U.S.C. § 3642 ............................................................................................1, 15, 54
39 U.S.C. § 3642(a) ...................................................................................................6
39 U.S.C. § 3642(b) ...................................................................................................6
*39 U.S.C. § 3642(b)(1) ......................................... 4, 6, 7, 16, 17, 19, 20, 25, 27, 53
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39 U.S.C. § 3642(b)(2).........................................................................................7, 16
39 U.S.C. § 3642(b)(3)...............................................................................................7
39 U.S.C. § 3663 ............................................................................................1, 24, 26
DECISIONS OF THE POSTAL REGULATORY COMMISSION
Analysis of USPS Financial Results and 10-K Statement for FY 2013
(P.R.C. Mar. 18, 2014) ........................................................................................55
Order No. 718, Docket No. C2009-1 (P.R.C. Apr. 20, 2011) .............................9, 58
Order No. 1828, Docket No. C2009-1R (P.R.C. Sept. 4, 2013)..............................15
SECONDARY SOURCES
Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law
(3d. ed. 2007) ....................................................................... 30, 34, 46, 47, 55, 58
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GLOSSARY
APA
Administrative Procedures Act
Commission
Postal Regulatory Commission
Flats
Large envelopes, newsletters and magazines that do not exceed
15 inches in length, 12 inches in height, or 3/4 inch in thickness
JA
Joint Appendix
PAEA
Postal Accountability and Enhancement Act of 2006
SEC
Securities and Exchange Commission
SA
Supplemental Sealed Appendix
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JURISDICTIONAL STATEMENT
This petition challenges Order No. 2306 of the Postal Regulatory
Commission (“Commission”), JA557-622, which rejected a request to create a
“competitive” postal product under 39 U.S.C. § 3642. This Court has jurisdiction
pursuant to 39 U.S.C. § 3663, under which any “person, including the Postal
Service, adversely affected or aggrieved by a final order or decision” of the
Commission may institute review proceedings in this Court. Order No. 2306 was
issued on December 23, 2014. This Petition was timely filed on January 21, 2015.
STATEMENT OF THE ISSUES
In determining that the Postal Service has “sufficient market power” over a
proposed postal product allowing companies to use the mail as a delivery channel
for providing consumers with access to movies and other digital entertainment
content, the Commission determined that, under principles of antitrust law, no
other methods by which consumers could obtain digital entertainment content are
reasonably interchangeable substitutes with “DVD-by-mail” service of such
content. The Commission therefore held that “DVD-by-mail” service is a product
market unto itself.
1.
Did the Commission err in defining the relevant product market?
Specifically:
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a.
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Did the Commission arbitrarily discount the uncontested fact
that large numbers of consumers have switched from DVD-by-mail service to
other methods of obtaining entertainment content as evidence that consumers view
such alternatives as reasonably interchangeable substitutes for DVD-by-mail?
b.
Did the Commission misapply the standard of “reasonable
interchangeability” under antitrust law when it held that differences in the
inventories of entertainment content available from companies using alternative
delivery channels are alone sufficient to place DVD-by-mail service in a separate
market?
c.
Did the Commission arbitrarily conclude that, because many
consumers still use DVD-by-mail service, such consumers must view alternative
methods of providing access to entertainment content as unreasonable substitutes?
d.
Did the Commission arbitrarily fail to consider the views of
content providers on whom their competitors are, despite stating that the view of
industry participants was relevant to the market definition?
2.
Even if the Commission properly limited the market to the physical
delivery of entertainment content by DVD through the mail, did the Commission
arbitrarily fail to consider factors relevant to whether the Postal Service has
sufficient power in that market, such as the countervailing buying power of the
largest DVD-by-mail service or the impact of rapid technological change?
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STATEMENT CONCERNING PERTINENT STATUTORY
PROVISIONS
The statutory provisions pertinent to this petition for review are set forth in
an addendum appearing at the end of this brief.
STATEMENT OF THE CASE
When an individual wants to watch a movie (or related entertainment
content) in her home, she has several options. She can stream or download the
movie digitally from her cable company’s “on demand” service or over the Internet
from a firm (like Amazon, Hulu, or Netflix) that provides digital access to such
content. She can buy it on DVD from an online retailer and have it delivered to
her. She can rent or buy it on DVD from a brick-and-mortar store. She can rent it
on DVD from a local kiosk (like Redbox). Or, she can rent it on DVD from an
online provider of DVD rentals and have it mailed to her. This case concerns
whether the last of those options, known as DVD-by-mail service, is a market unto
itself or whether it competes with some or all of the other options in a broader
market for access to movies and similar digital content. Put another way, the issue
here is whether there are any reasonably interchangeable substitutes for
entertainment content that is rented on a DVD and delivered by the mail.
The instant petition arises from an order of the Postal Regulatory
Commission (“Commission”), Order No. 2306, JA557-622, rejecting a request to
create a new “competitive” postal product that companies offering DVD-by-mail
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service would use to send their content to their customers and to receive that
content from their customers in return. Whether a proposed product is deemed
“market-dominant” (and therefore covered by an inflation-based price cap) or
“competitive” (and thus more lightly regulated) turns on whether the Commission
concludes that, among other things, the product is one in which the Postal Service
“exercises sufficient market power” such that it can set prices substantially above
costs or raise prices significantly “without risk of losing a significant level of
business to other firms offering similar products.” 39 U.S.C. § 3642(b)(1).
DVD-by-mail service is the only method of distributing digital entertainment
content that uses the mail, but is not the only method of distributing digital
entertainment content. The only direct buyers of the proposed postal product are
those firms – now consisting almost exclusively of two firms, Netflix and GameFly
– that choose to offer their content to customers through DVD-by-mail service.
Because the postal product is used only when customers demand movies through
DVD-by-mail service (as opposed to a different service), demand for the postal
product is derived entirely from, and is coextensive with, consumer demand for
DVD-by-mail service. Accordingly, the Commission rightly determined that its
inquiry under Section 3642(b)(1) starts by asking whether there is adequate
competition for Netflix’s and GameFly’s DVD-by-mail service, i.e., whether
DVD-by-mail service is its own product market under principles of antitrust law or
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Purporting to apply such antitrust
principles, the Commission concluded that the alternatives to DVD-by-mail service
for distributing movies and games are not sufficiently close competitors.
Specifically, it held that a core group of consumers who presently use DVD-bymail service does not view other methods of watching movies or playing video
games to be reasonable substitutes for DVD-by-mail service. It accordingly denied
the Postal Service’s request.
STATEMENT OF THE FACTS
A.
“Market-Dominant” and “Competitive” Products under Title 39.
The Postal Reorganization Act of 1970, Pub. L. No. 91-375, 84 Stat. 719
(1970), created the Postal Service as an independent establishment of the executive
branch of the government, 39 U.S.C. § 201, and imposed a “cost of service”
ratemaking model under which the Postal Service was entitled to rates that would
provide it with sufficient revenues to cover its projected costs. 39 U.S.C. § 3621
(2005); see United Parcel Serv., Inc. v. U.S. Postal Serv., 184 F.3d 827, 829-30
(D.C. Cir. 1999).
In 2006, Congress enacted the Postal Accountability and Enhancement Act
(“PAEA”), Pub. L. No. 109-435, 120 Stat. 3198, which repealed the cost-based
“break even” pricing model and gave the Postal Service enhanced flexibility to set
prices for its individual products.
The restrictions on that flexibility depend
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primarily on whether a given product is “market-dominant” or “competitive.” The
principal restriction on “competitive” products is a price floor:
individual
competitive products must cover their “attributable” costs and products collectively
must cover “an appropriate share” of the Postal Service’s “institutional costs.” 39
U.S.C. § 3633. “Market-dominant” products, by contrast, are subject to a price
cap, id. § 3622(d)(1), which generally forecloses the rates charged for classes of
market-dominant products to rise above the rate of inflation.
As for whether a postal product is “market-dominant” or “competitive,” the
critical question in this proceeding, the PAEA provides a list of “market-dominant”
products, 39 U.S.C. § 3621(a), and a list of “competitive” products, id. § 3631(a),
see also id. §§ 102(8)-(9) (defining “market-dominant” and “competitive”
product), and empowers the Commission (upon request of the Postal Service or a
mailer or on its own initiative) to change the list of products, add or remove
products from the lists of market-dominant or competitive products, or move
products between lists. Id. §§ 3621(a), 3631(a), 3642(a). The standards governing
whether a product should be deemed “market-dominant” or competitive” are set
forth in 39 U.S.C. § 3642(b).
The pertinent standard in this review proceeding is found in Section
3642(b)(1), which provides that:
The market-dominant category of products shall consist of each
product in the sale of which the Postal Service exercises sufficient
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market power that it can effectively set the price of such product
substantially above costs, raise prices significantly, decrease quality,
or decrease output, without risk of losing a significant level of
business to other firms offering similar products. The competitive
category of products shall consist of all other products.
39 U.S.C. §3642(b)(1). Even where a product meets that standard, the statute
further excludes from the “competitive” category products that are covered by the
“postal monopoly,” id. § 3642(b)(2), which generally applies to the transmission of
letters, and requires the Commission to give “due regard” to the considerations set
forth in Section 3642(b)(3).
B.
Netflix’s and GameFly’s “DVD-By-Mail” Service and Other
Methods of Providing Access to Digital Entertainment
Content.
“DVD-by-mail” service refers to one of the channels through which a
company can provide its customers with access to its digital entertainment content.
GameFly and Netflix are companies that provide DVD-by-mail service to their
customers. JA563. 1 Netflix is a popular online service that rose to prominence by
allowing subscribers to watch films, television shows, and similar video content by
having such content delivered on DVD, through the mail, to a subscriber’s mailbox
or other postal receptacle. GameFly is an online video game rental service that,
like Netflix (but on a far smaller scale), allows its subscribers to play digital video
1
Unless otherwise indicated, the facts concerning Netflix, GameFly, and their
“DVD-by-mail” services are undisputed. Many of the basic facts were established
in Commission Docket No. C2009-1, which gave rise to the instant proceedings.
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games by having such content delivered on DVD, through the mail, to a
subscriber’s mailbox or other postal receptacle.
In providing DVD-by-mail service, both Netflix and GameFly use round-trip
envelopes (known as “mailers”) to distribute DVDs to their customers, who in turn
mail the DVDs back to the companies in the same pre-addressed envelopes. Each
company pays the postage for both directions of these “round trip” mailings, and
initiates such mailings when a new customer subscribes to the service and places
an order over the Internet for a particular game or movie or when an existing
subscriber returns a rented game or movie and has pre-selected another game or
movie on a list that the customer maintains on the firm’s website. The companies
charge their customers a monthly subscription fee for renting movies or games.
Although both companies at one time exclusively “used DVDs delivered and
returned by mail as the medium for providing digitized entertainment content to
their customers,” JA563, the companies have each diversified by expanding into
other delivery channels. Since 2007, Netflix has offered to its subscribers the
opportunity to watch such content streamed over the Internet. This effort has been
wildly successful – in its filings with the Securities and Exchange Commission
(“SEC”), Netflix now refers to itself as the “world’s leading Internet television
network” and “a pioneer in the Internet delivery of TV shows and movies.”
Netflix, Inc., Annual Report for Fiscal Year ended Dec. 31, 2013 (Form 10-K), at 1
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(hereafter “Netflix 2013 Annual Report”), available at http://tinyurl.com/ln3r3na;
Netflix, Inc., Annual Report For Fiscal Year ended Dec. 31, 2012 (Form 10-K), at
1
(hereafter
“Netflix
2012
Annual
Report”),
available
at
http://tinyurl.com/kqv5ce2. GameFly has also attempted to use other delivery
channels – renting games through kiosks and offering digital downloads over the
Internet – to disseminate its content. JA80-81, JA87, Separate Sealed Appendix
(“SA”) at SA754-55. 2
Unlike Netflix, GameFly also sells its content to its
customers. JA563.
Netflix has long been by far the largest user of the mail as a distribution
channel to provide access to its entertainment content. For example, in 2010,
Netflix generated 97 percent of all DVD mail volume; Blockbuster, Inc., generated
2 percent; and GameFly generated 1 percent. Initial Br. of U.S. Postal Serv.,
Docket No. C2009-1, at 2, 66, 109 (P.R.C. filed Nov. 8, 2010), available at
http://tinyurl.com/kxbtrpu; Order No. 718, Docket No. C2009-1, at 58 (P.R.C. Apr.
20, 2011), available at http://tinyurl.com/n4sdfo3. Blockbuster’s DVD-by-mail
service was liquidated in late 2013, JA440, leaving Netflix and GameFly as the
only significant content providers that still offer DVD-by-mail service. Netflix’s
2
In 2014, GameFly announced that it would begin offering movies for rental, thus
expanding its content offerings. JA563.
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share of total DVD mail volume has remained relatively stable, with Netflix
accounting for roughly 98 percent of all volume in recent years. See SA758. 3
Netflix has claimed, probably without exaggeration, that its DVD-by-mail
service “changed the way many American’s [sic] rent and watch movies and TV
shows.”
Comment of Netflix, Docket No. C2009-1, at 3 (Nov. 18, 2010),
available at http://tinyurl.com/kbnfen4. Retail stores like Blockbuster had been
the principal method by which consumers rented entertainment DVDs, but
Netflix’s choice of distribution method proved to give it a competitive advantage
over incumbent brick-and-mortar stores. Blockbuster went bankrupt, as GameFly
correctly noted, because “it relied primarily on a large network of retail stores to
distribute retail DVDs to consumers, and could not compete with the lower-cost
distribution model of Netflix, which did not use retail stores.” JA440. As the
Commission observed, “the advent of Netflix’s DVDs-by-mail service resulted in
the decline and eventual exit of Blockbuster and other large brick and mortar
suppliers of DVD rental services.” JA594.
Although mail delivery remains a viable method of distributing
entertainment content, there is no escaping the fact that DVD-by-mail volume has
declined at an alarming rate in recent years. For Netflix, mail delivery of DVDs
3
SA758 was filed with the Commission in January 2014, JA402-08, and contains
monthly mail volumes (including DVDs shipped to customers and returned from
customers) generated from Netflix (since October 2006) and from GameFly (since
October 2010) through December 2013.
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peaked in 2010, see JA172, SA741, after which it reported a 14 percent year-overyear decline in 2011 in the number of DVDs mailed to subscribers, Netflix 2012
Annual Report, at 24; a further 41 percent decline in 2012, id. at 23; a further 21
percent decline in 2013, Netflix 2013 Annual Report, at 21; and a further 22
percent decline in 2014. Netflix, Inc., Annual Report for Fiscal Year ended Dec.
31, 2014 (Form 10-K), at 21 (hereafter “Netflix 2014 Annual Report”), available
at http://tinyurl.com/kq3t62o.
See also SA741 (Netflix DVD-by-mail rentals,
2006-2012); SA758 (combined outbound and inbound mail-volume figures for
Netflix between October 2006 and December 2013); JA172 (noting 58 percent
volume decline between the end of FY2010 and the end of FY2013). GameFly
does not file annual reports with the SEC and did not provide volume data in
response to the Commission’s request for “total revenue and volume from product
rentals distributed . . . [o]n DVDs via the mail,” JA366, see SA747-57 (GameFly
response), but the data that the Postal Service filed with the Commission showed
that GameFly has also experienced considerable volume declines since 2011.
SA758; accord JA172 (noting 29 percent volume decline between the end of
FY2011 and the end of FY2013).
Those rapid, dramatic losses did not occur in a vacuum – no one suggests
that their customers suddenly lost interest in watching movies or playing video
games during this period. Instead, consumer demand for DVD-by-mail service has
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declined as consumers have switched to other methods of obtaining videos and
video games. JA142-43; SA630; SA632-34; SA637-39.
DVD-by-mail service is not, and has never been, the only way for
consumers to rent DVDs. In June 2013, even as Blockbuster’s model was on the
brink of collapse, DVD-by-mail service accounted for roughly 24 percent of DVD
rental revenue, brick-and-mortar retail stores accounted for 24 percent, and “kioskbased” rentals accounted for 49 percent. SA626. The leading kiosk-based rental
business is Redbox (owned by Outerwall Inc.), which operates more than 40,000
kiosks nationwide, primarily in “leading grocery stores, mass retailers, drug stores,
restaurants and convenience stores.” Outerwall Inc., Annual Report for Fiscal
Year ended Dec. 31, 2013 (Form 10-K), at 1 (hereafter “Outerwall 2013 Annual
Report), available at http://tinyurl.com/orctsf7. In its SEC filings, Outerwall noted
that its “Redbox kiosks supply the functionality of a traditional video rental store,
yet typically occupy an area of less than ten square feet.” Id. The business has
been successful, accounting for roughly half of all DVD rental revenue by mid2013, SA626 (45.5 percent of DVD rental revenue), JA142 (50.6 percent). As the
Commission acknowledged, Redbox rents more DVDs than Netflix and more
video-game DVDs than GameFly. JA591.
Just as DVD-by-mail service is not the only way in which a customer can
rent a DVD, renting a DVD is not the only way a customer can watch a movie or
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play a video game at home. Of particular note is the massive growth of streaming
over the Internet or through video-on-demand services provided by cable and
satellite networks. Netflix’s streaming service has been astonishingly successful,
of course, showing year-over-year growth in its paid streaming subscriber base of
26 percent in 2012, Netflix 2012 Annual Report at 22; 25 percent in 2013, Netflix
2013 Annual Report at 19; and 19 percent in 2014, Netflix 2014 Annual Report at
18. Indeed, the vast majority of Netflix’s customers now subscribe to its streaming
service rather than its DVD-by-mail service, with some customers subscribing to
both. SA746. And Netflix is far from the only firm that offers streaming service –
by its own account, its streaming competitors include Amazon’s Prime service and
digital “on demand” services offered by cable companies. Netflix 2012 Annual
Report at 2. Consumer spending on video-on-demand services increased by 11
percent in 2012 alone, a year in which rentals of physical media decreased by 12
percent. SA632-33.
C.
Previous Proceedings in the Commission and This Court’s
GameFly I and GameFly II Decisions.
As the Commission noted, JA560, the instant case is an outgrowth of a prior
Commission proceeding that led to this Court’s decisions in GameFly, Inc. v.
Postal Regulatory Commission, 704 F.3d 145 (D.C. Cir. 2013) (“GameFly I”) and
U.S. Postal Service v. Postal Regulatory Commission, 747 F.3d 906 (D.C. Cir.
2014) (“GameFly II”). That proceeding did not concern the position of DVD-by13
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mail service relative to other methods of providing access to movies and games,
but instead concerned the relative positions of Netflix and GameFly vis-à-vis the
Postal Service.
The two companies use different envelopes, of different weights, to send
DVDs to their customers. Netflix sends and receives DVDs as one-ounce FirstClass Mail Letters, whereas GameFly sends and receives DVDs as two-ounce
First-Class Mail Flats. One-ounce letters cost the Postal Service less to process –
they are smaller and lighter than two-ounce flats and are processed on less costly
machines – so the price of a one-ounce letter is generally lower than the price of a
two-ounce flat. As a result, GameFly historically paid more per-piece postage than
Netflix did in sending and receiving DVDs.
In 2009, GameFly filed a complaint with the Commission, alleging that the
Postal Service was offering preferential rates and terms of service to Netflix in
violation of the antidiscrimination provision in 39 U.S.C. § 403(c).
JA563.
Specifically, GameFly alleged that the Postal Service provided special manual
processing to Netflix for its DVDs, and did so for free, but refused to offer similar
terms to GameFly, which effectively forced GameFly to use the more expensive
two-ounce flats to guard against DVD breakage. The Commission ruled that the
Postal Service had unlawfully discriminated in favor of Netflix and against
GameFly with respect to rates and terms of service. JA563. The Commission
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fashioned a “rate remedy” that this Court set aside for failing either to fully redress
the discrimination it found or to explain why any residual discrimination it left in
place was reasonable. GameFly I, 704 F.3d at 148-49.
On remand, the Commission ordered the Postal Service to charge the same
price for Netflix’s one-ounce letters as for GameFly’s two-ounce flats, either by
charging the one-ounce letter rate for both products or by creating a new rate that
would apply to both products. GameFly II, 747 F.3d at 908-09. On July 26, 2013,
in response to that Order, the Postal Service proposed a new product, tentatively
called the “Round-Trip Mailer,” to replace the existing options for mailing DVDs.
Id. at 909; JA1-24. Under the Postal Service’s proposal, the initial price for the
Round-Trip Mailer would equal the price at that time of a one-ounce letter, and the
product would be classified as a “competitive” product under 39 U.S.C. § 3642.
JA7. The Commission deferred ruling on whether the proposed product should be
deemed “market-dominant” or “competitive” under Section 3642, and opened the
instant proceeding to resolve that issue.
In the meantime, it approved the
“equalized rate” that the Postal Service proposed for its DVD-by-mail offerings.
See Order No. 1828, Docket No. C2009-1R (P.R.C. Sept. 4, 2013), available at
http://tinyurl.com/pvcluym; accord GameFly II, 747 F.3d at 909.
affirmed the remedy. Id. at 910-13.
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D.
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Instant Proceedings Before the Commission.
The Postal Service argued that the proposed Round-Trip Mailer should be
classified as a “competitive” product because mail delivery was only one of many
channels through which content providers could give consumers access to their
libraries of movies, games, and other digital entertainment content, and because the
competition among content providers (and among methods that firms used to
provide access to such content) would restrict the Postal Service’s ability to price
the Round-Trip Mailer above a competitive level. Both Netflix and GameFly
objected to the creation of a “competitive” product for mailing DVDs, arguing that
the Postal Service had “market power” over the proposed product within the
meaning of Section 3642(b)(1) and that, in any event, the proposed product was
covered by the postal monopoly and thus could not be deemed a competitive
product under Section 3642(b)(2).
The parties disagreed dramatically over how to define the market for
purposes of analyzing whether the proposed product had “sufficient market power”
under Section 3642(b)(1). The Postal Service argued that the market should
include all of the various methods for providing entertainment content that
consumers of such content would view as reasonable substitutes for DVD-by-mail
service. GameFly sought to shift the focus away from consumers and toward itself
and Netflix. Rather than asking whether customers perceive access to movies and
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games through other channels to be reasonable substitutes to access to movies and
games through DVD-by-mail service, GameFly argued that the Commission
should instead focus on whether the companies that have already chosen to use the
mail to deliver their content would perceive other forms of dissemination as
interchangeable with mail delivery. E.g., JA246-47. Even if the market definition
should focus on whether consumers view alternatives to DVD-by-mail as
reasonable substitutes, GameFly continued, digital or kiosk distribution of movies
and games are unacceptable substitutes “for the core group of consumers that have
chosen to continue renting DVDs by mail from Netflix and GameFly.” JA259-60.
Over the course of eight months, the Postal Service, GameFly, Netflix, and a
Public Representative appointed by the Commission, submitted several rounds of
comments, evidence, and responses to information requests by the Commission,
setting forth their contrasting views on the relevant market and the Postal Service’s
power (if any) in that market.
E.
The Commission’s Final Order.
On December 23, 2014, nearly 17 months after initiating proceedings, the
Commission rejected the Postal Service’s request. JA557-622.
The Commission concluded that the “market power” question under 39
U.S.C. § 3642(b)(1) should be governed by principles of federal antitrust law,
JA573-74, and that its analysis must begin by identifying the relevant product
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market and geographic market.
JA574.
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After concluding that the relevant
geographic market is “the U.S. domestic market,” JA574, the Commission’s
analysis was devoted mostly to defining the relevant product market. JA574-604.
Quoting the Supreme Court’s decision in Brown Shoe Co. v. United States,
370 U.S. 294, 325 (1962), the Commission professed that the “outer boundaries of
a product market are determined by the reasonable interchangeability of use or the
cross-elasticity of demand between the product itself and substitutes for it.”
JA574. Whether products are reasonably interchangeable “involves consideration
of ‘the purposes for which they [the products] are produced- price, use and
qualities considered,’” JA575 (quoting U.S. v. E.I. duPont de Nemours & Co., 351
U.S. 377, 404 (1956) (alteration in Order), and “can also involve consideration of
customer views, as well as industry or public perceptions of markets or a firm’s
perception of who its competitors are.” JA575. The same considerations, the
Commission continued, could be used to establish “submarkets” within a broader
product market. JA576.
After evaluating the parties’ positions, the Commission concluded that the
relevant market is “the market for round-trip physical delivery of rented videos and
games via a DVD mailer.” JA604. The Commission based its conclusion on four
“findings and conclusions”: (1) that there must be a “demonstration” that “other
products” providing consumers access to movies and video games “are reasonable
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substitutes for DVDs-by-mail,” and such demonstration is not made merely by
noting the “increase in the availability of digitized entertainment content by other
means,” JA603; (2) that “alternatives to the delivery of digitized entertainment
other than DVDs-by-mail are subject to significant limitations” and thus do not
provide “all” the content “made available by means of DVDs-by-mail,” JA603-04;
(3) that a “core group of consumers of digital [entertainment] content perceive
DVDs-by-mail as a separate product market for which there are no reasonably
available economic substitutes,” JA604; and (4) that, while “industry participants
anticipate technological developments that will one day make all, or most, digital
content available by delivery systems other than DVDs-by-mail,” such equality of
content is not “currently” available. JA604.
After limiting the relevant market to DVD-by-mail service, the Commission
then concluded that the Postal Service could not show that it lacks market power.
JA606-13.
The Commission noted that its decision was “without prejudice,”
meaning that “[l]egal, commercial, and technological developments might at some
point permit the Postal Service to establish the adequacy of competition in the
digitized entertainment content market to prevent it from exercising market power
described in section 3642(b)(1).” JA562. Having found that such competition
does not currently exist, however, the Commission denied the Postal Service’s
request. This petition followed.
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SUMMARY OF THE ARGUMENT
The key question in this case is whether the relevant product market is the
provision of digital entertainment content (regardless of delivery method), or the
rental of digital entertainment content by physical delivery of DVDs through the
mail. The Commission’s market-power analysis under 39 U.S.C. § 3642(b)(1)
rests almost entirely on its decision that the latter is the relevant market. That
market definition, and therefore the Commission’s analysis of the Postal Service’s
power in the market, is the result of a deeply flawed analysis and an arbitrary
application of the antitrust principles on which the Commission purported to rely.
The Commission’s broad analytical framework is permissible under the
statute. Noting that the demand for the proposed postal product is driven entirely
by consumer demand for DVD-by-mail service, the Commission properly focused
on the competition faced by that service – i.e., whether other methods of providing
access to movies and other digital entertainment content are reasonably
interchangeable substitutes for DVD-by-mail service – and properly relied entirely
on antitrust law to determine whether, in fact, such reasonably interchangeable
substitutes exist.
Having properly framed the question, and having articulated several antitrust
principles to aid in answering it, however, the Commission completely misapplied
the articulated principles. After discounting the undeniable fact that consumers are
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switching at an astonishing rate from DVD-by-mail service to alternative methods
of watching movies and playing games, the Commission relied on three factors to
overcome the seemingly inescapable inference that consumers view other methods
of receiving digital content as reasonably interchangeable with DVD-by-mail
service and to conclude that the latter is in a product market of its own for which
there are no substitutes.
First, the Commission focused on the fact that not every single movie or
every game available from the firms providing DVD-by-mail service is available
through every alternative channel for receiving content, a fact the Commission
attributed to “limitations” inherent in those other delivery channels, and concluded
that the differences in inventory preclude the different channels from being
reasonable substitutes for each other. That reasoning is both factually and legally
flawed – factually because it wildly overstates the degree and breadth of such
“limitations”; and legally because it requires products to be identical in order to be
reasonable substitutes, an unsustainable interpretation of antitrust law. If two
services had to be literally identical in order to be acceptable substitutes in the
same market, there could never be a market consisting of differentiated products,
as each product from each firm would be a market unto itself.
Second, and relatedly, the Commission concluded that differences in
inventory are critical to a “core group” of customers who prefer DVD-by-mail
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service and who accordingly do not perceive a movie streamed over the internet or
rented from a kiosk to be a reasonable substitute to a movie rented through the
mail. But that analysis improperly focused only on the current users of a single
product, and in any event is a proposition with no factual basis – if it were true that
GameFly’s or Netflix’s customers were captive to DVD-by-mail service, the use of
such service would not be in freefall. More important, even if some of GameFly’s
or Netflix’s customers are unusually loyal and would not leave DVD-by-mail
service for other firms using other distribution channels, that fact alone is
insufficient to create a separate market of “core customers.” Rather, there must be
evidence that the supposedly “core” group is identifiable and loyal enough for a
firm to engage in price discrimination against it or that it is large enough to allow a
firm to raise prices on all its customers profitably. Here, the Commission points to
no evidence that such a core group exists, let alone that its characteristics are such
that Netflix or GameFly would have unusual pricing power over them (or that the
Postal Service could somehow exploit such power).
Third, the Commission purported to focus on the views of industry
participants on who their competitors are, but managed to avoid any discussion of
that issue or the evidence that industry participants perceive their competitors to
include content providers who use delivery channels other than physical delivery
through the mail.
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The result of the Commission’s arbitrary antitrust analysis is its baffling and
equally arbitrary conclusion that, despite the fact that companies provide access to
digital entertainment content through a variety of channels, and despite the fact that
consumers are switching away from DVD-by-mail service in droves to those
alternatives, the alternatives are somehow in a different product market from
DVD-by-mail service. In essence, the Commission concluded that firms providing
access to digital entertainment content through a particular delivery channel
compete only with firms that use the same delivery channel to provide such access.
The Commission’s arbitrary definition of the market is alone sufficient to
overturn the Commission’s order. But even if the Commission correctly limited
the market to DVD-by-mail service, the Commission ignored important
considerations bearing on whether the Postal Service has market power.
Specifically, it did not consider the countervailing buying power of its largest
customer, Netflix, even though this case is an outgrowth of a proceeding that was
premised on the unusual power that Netflix holds over the Postal Service. It also
did not consider the fact that the market, however defined, is in the process of rapid
technological change, an inherent limit on market power. For these independent
and additional reasons, the Commission’s order should be set aside.
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STANDING
The Postal Service has standing under 39 U.S.C. § 3663 to challenge Order
No. 2306. It is “adversely affected or aggrieved” by the Commission’s order
because it undermines the Postal Service’s flexibility to set market-responsive
prices for delivering DVDs and instead subjects such prices to the artificial
restraint of a price cap. As a result, if the marketplace changes or if the unit cost of
delivering DVDs rises, the Postal Service cannot respond to such events without
reducing the prices charged for other postal products, which will result in a
reduction of needed revenue.
While the Postal Service cannot say that it would have raised the price of
DVD delivery had the Commission properly concluded that the proposed RoundTrip Mailer is a “competitive” product, it need not make such a representation to
have standing under Section 3663.
A regulated party may be prospectively
injured, for example, by a decision that claims excessive agency authority, Int’l
Bhd. of Elec. Workers v. ICC, 862 F.2d 330, 334 (D.C. Cir. 1988) (claim that
agency lacked authority to review arbitration awards), or by a rule that imposes
more regulatory burdens than are permitted by statute, Ass’n of Am. R.Rs. v. Dep’t
of Transp., 38 F.3d 582, 585 (D.C. Cir. 1994) (claim that agency rule improperly
subjected plaintiff to otherwise inapplicable regulations). The mere adoption of an
improper legal principle is sufficient to cause such injury. See id. This Court can
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redress these injuries by granting the petition for review and setting aside the
Commission’s conclusions as contrary to law, arbitrary, and capricious.
ARGUMENT
I.
STANDARD OF REVIEW
The Commission determined that (1) the inquiry under Section 3642(b)(1)
begins by defining the market, analyzing whether DVD-by-mail service is
reasonably interchangeable with alternative methods of providing access to digital
entertainment content, and (2) the question of reasonable interchangeability is
governed by principles of antitrust law. JA573. That framework has not been
“unambiguously foreclosed” by the text of Section 3642(b)(1), see Catawba Cty.,
N.C. v. EPA, 571 F.3d 20, 35 (D.C. Cir. 2009), and it otherwise is a reasonable
framework within which to analyze market power under the statute, so it survives
the two-step standard for deference under Chevron, U.S.A., Inc. v. Natural
Resources Defense Council, Inc., 467 U.S. 837, 842 (1984).
Because the
Commission’s analysis rests on its application of antitrust principles and thus on
laws that the Commission does not administer and in which it has no special
expertise, it can claim no deference for such application.
See Ass’n of Civ.
Technicians v. FLRA, 250 F.3d 778, 782 (D.C. Cir. 2001); Dep’t of Treasury v.
FLRA, 837 F.2d 1163, 1167 & n. 5 (D.C. Cir. 1988). Accordingly, this Court
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should review the Commission’s determination, including its application of
antitrust law, under the Administrative Procedures Act (APA).
Under Section 706 of the APA, 5 U.S.C. § 706; see also 39 U.S.C. § 3663
(courts shall review Commission orders under APA Section 706), an agency order
must be held unlawful and set aside if, among other things, it is “arbitrary,
capricious, an abuse of discretion, or otherwise not in accordance with law,” 5
U.S.C. § 706(2)(A), or is “unsupported by substantial evidence.” Id. § 706(2)(E).
An agency decision can be struck down under this standard if, for example, it is
“devoid of needed factual support,” Ass’n of Data Processing Serv. Orgs. v. Bd. of
Governors of the Fed. Reserve Sys., 745 F.2d 677, 683 (D.C. Cir. 1984); it lacks a
“rational explanation . . . based on consideration of the relevant factors,” Am.
Fed’n of Gov’t Employees v. FLRA, 470 F.3d 375, 380 (D.C. Cir. 2006) (citation
omitted); or there is no “reasoned path” from the facts and circumstances before
the agency to the decision it reached, or the decision is “illogical on its own terms.”
id. (citations omitted). “Put simply, the APA requires that an agency's exercise of
its statutory authority be reasonable and reasonably explained.” Mfrs. Ry. Co. v.
Surface Transp. Bd., 676 F.3d 1094, 1096 (D.C. Cir. 2012).
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THE COMMISSION ERRED IN DEFINING THE RELEVANT
PRODUCT MARKET AS BEING LIMITED TO ENTERTAINMENT
CONTENT THAT IS DISTRIBUTED BY MAIL.
As noted above, the Postal Service does not contest the broad framework
within which the Commission analyzed whether the proposed Round-Trip Mailer
product has “sufficient market power” under 39 U.S.C. § 3642(b)(1).
The
Commission concluded that it could not determine whether the Postal Service has
sufficient “market power” without first defining the relevant product market in
which the Round-Trip Mailer exists. JA574. Recognizing that the product-market
definition focuses largely on consumer demand, JA577, the Commission noted that
the direct purchasers of the Round-Trip Mailer product are Netflix and GameFly,
JA595, but those firms purchase the postal product (and the postal product is used)
only when their subscribers request a DVD from Netflix or GameFly or return a
DVD to those companies. Put differently, consumer demand for the DVD-by-mail
service that Netflix and GameFly provide drives (and is coextensive with) the
demand for the Postal Service’s product. JA595. Accordingly, the Commission’s
analysis correctly focused on whether Netflix’s and GameFly’s “DVD-by-mail”
service competes “to a substantial degree” with other means by which consumers
can obtain digital entertainment, i.e., whether consumers see such alternatives as
reasonably interchangeable substitutes for DVD-by-mail service.
JA574-75,
JA577. See U.S. v. E.I. du Pont de Nemours & Co., 351 U.S. 377, 395 (1956)
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(product market consists of all products that are “reasonably interchangeable by
consumers for the same purposes.”); Levitch v. Columbia Broadcasting Sys., Inc.,
495 F. Supp. 649, 664-65 (S.D.N.Y. 1980) (relevant market for determining
whether television networks monopolized the programs aired on their networks is
measured not from perspective of creators of content or from network affiliates
who purchase and transmit the content, but from the viewing public who ultimately
consumes the content), aff’d, 697 F.2d 495 (2d Cir. 1983).
That framework should have led the Commission to the obvious conclusion
that firms using DVD-by-mail service compete in a market that extends far beyond
the rental of physical DVDs, let alone the rental of physical DVDs that use roundtrip mail delivery as the method of distribution, and accordingly that the
distribution channel that the Postal Service provides is one of many channels (and
an increasingly minor one) that firms may choose to use to disseminate their
entertainment content to potential customers. But the Commission concluded that
there is inadequate competition in the broader “digitized entertainment content
market,” JA562, and therefore that the relevant market should be defined as “the
market for round-trip physical delivery of rented videos and games via a DVD
mailer.” JA604.
The Commission based its conclusion on four factors, summarized in its
“Findings and Conclusions” section at JA603-04. As set forth in the following
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four parts, none of the articulated factors supports the conclusion, under the
antitrust principles that the Commission determined would govern the case, that
entertainment content provided by “DVD-by-mail” service exists in a “separate
product market” from entertainment content provided through other delivery
channels.
A.
The Proposition that the Mere Availability of Alternative Delivery
Channels Does Not Prove that They Are “Reasonable Substitutes”
for DVD-By-Mail Service is Beside the Point.
The Commission begins its “findings and conclusions” by observing that, to
demonstrate that DVD-by-mail service is part of a broader market that also
encompasses “other technologies to deliver movie in game content,” it is not
enough to point to “the decline in DVD mail volume and the simultaneous increase
in the availability of digitized entertainment content by other means (such as
Internet streaming, Internet downloading, cable TV, satellite TV, kiosks, retail
sales, and other delivery systems).” JA603. Rather, the Postal Service must show
that products using “these other technologies to deliver movie and game content . .
. are reasonable substitutes for DVDs-by-mail.” JA603. Those statements are not
incorrect, but are a red herring – the Postal Service’s point was not merely that
other means of providing access to movies and games are “available,” but that
consumers have actually switched to those other means of receiving movies and
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games. In other words, the Postal Service showed actual substitution to, not the
mere availability of, alternatives to DVD-by-mail service.
Actual substitution is strong evidence that consumers regard two products as
reasonable substitutes. See IIB Phillip E. Areeda & Herbert Hovenkamp, Antitrust
Law ¶ 562, at 371 (3d. ed. 2007) (“actual shifts between two products in response
to – or even without – changes in their relative prices indicate a single market”).
And there is no serious dispute that astonishing numbers of customers in recent
years have switched away from DVD-by-mail rentals and toward other methods of
obtaining access to movies and games. As noted above, Netflix’s DVD-by-mail
rentals dropped by 58 percent between 2010 and 2013, and its SEC filings reveal a
similarly precipitous increase in streaming of movies and similar content during
that period. At the same time, customers still seeking to rent a physical DVD now
rent more movies from Redbox kiosks than from Netflix’s DVD-by-mail service.
JA591. See SA635 (industry analysis noting that Netflix’s DVD-by-mail service
has been “cannibalized” by kiosk rentals and online streaming); JA636 (“direct
substitutes” like streaming and video-on-demand have caused demand for DVD
rentals to decline). Although, for reasons set forth below, game-rental figures are
not as important to the analysis, GameFly’s figures tell a similar story. Rentals of
video games by mail declined by 29 percent between 2011 and 2013, JA172, while
Redbox – the kiosk-based DVD rental service – rents more games on DVD than
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GameFly does, and digital-only methods of playing video games have increased to
the point that, as the Commission apparently accepts, they may account for twothirds of the entire video-game market by 2017. JA589.
There is nothing in the record suggesting that the contrasting trends are
merely coincidental – for example, that the customers leaving DVD-by-mail
simply have lost interest in watching movies or playing games at the same time
that a completely different group of customers who never rented DVDs by mail
suddenly started watching movies and playing games through other channels. To
the contrary, both Netflix and GameFly acknowledge that they and their nonDVD-by-mail competitors compete for the same consumers. See infra Part II.D.
The uncontroverted evidence of actual substitution certainly supports the
presumption that alternative services through other delivery channels are
substitutes for DVD-by-mail service.
The rest of the Commission’s analysis
consists of its attempt to use other factors – specifically, the asserted existence of
“important limits” on alternatives to DVD-by-mail rentals, JA581, and the
proposition that “certain customers” now using DVD-by-mail service “either prefer
or require DVDs-by-mail service to consume certain video content,” JA572 – to
rebut that presumption. As discussed in the following sections, those other factors
do not support the conclusion that DVD-by-mail service is devoid of reasonable
substitutes and thus is in a product market of its own.
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The Commission’s Analysis of the Differing Inventories Among
Content Providers Does Not Support a Conclusion that Such
Companies Compete In Different Markets.
The Commission does not deny that the method by which a movie is
delivered does not affect the consumer’s viewing experience. A movie looks the
same on screen whether it is rented and viewed on a DVD delivered by the Postal
Service, rented on a DVD from a kiosk, or streamed or downloaded over the
internet. But the Commission found that “limitations” on delivery methods other
than mail delivery prevent all content from being available through all channels.
Because such limitations exist, the Commission reasoned, they prevent other
delivery methods from being “reasonable substitutes to DVDs-by-mail for all
content at this time” and accordingly place those delivery methods in a separate
product market. JA603-04.
The Commission’s analysis, expanded upon at JA582-94, boils down to a
syllogism:
(1) to compete in the same product market, two services providing access to
movies or games must provide the same content (i.e., must have the same
inventory);
(2) while most “digital movies and games can be viewed as available from a
broad spectrum of sources (DVDs, Internet streaming, Internet downloading,
kiosks, cable TV, satellite TV, retail sales, etc.),” JA602, some movies and games
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are available to consumers only through DVDs delivered by mail because of
various “limitations” on other delivery methods, JA583-94;
(3) therefore, because not every single movie and game available on DVD
delivered by mail is also available through streaming or other distribution
channels, services using mail delivery and services using other distribution
channels must be in different product markets.
As discussed below, the first premise is simply false – two services need not
be perfect or identical substitutes in order to be reasonable substitutes under
antitrust law. The second premise founders because the Commission’s discussion
is limited almost entirely to one channel (streaming), delivering only one type of
content (video games), and does not support the conclusion in any event.
1.
Products Can, And Do, Compete in the Same
Market Despite Not Having Literally Identical Content.
To be sure, there are some differences in the content available from, for
example, Netflix’s DVD-by-mail service and Netflix’s streaming service, just as
there are differences between the latter service and Amazon’s Prime streaming
service. Far from suggesting a lack of competition, those differences are a basis on
which those services compete.
It is well-settled, and completely intuitive, that products need not be
homogenous or fungible in order to compete in the same product market. U.S. v.
Continental Can Co., 378 U.S. 441, 449 (1964) (citing E.I. du Pont, 351 U.S. at
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394). Accordingly, even where customers perceive two products as different, the
products are in the same market if they perform the same essential function and
they compete for the same customers, as the Commission essentially
acknowledged when it stated that products are in the same market if they compete
“to a substantial degree,” i.e., if the products are reasonably interchangeable
substitutes. JA574-75, 577. See E.I. du Pont, 351 U.S. at 395 (product market
consists of all products that are “reasonably interchangeable by consumers for the
same purposes.”). But when it came time to apply that standard, the Commission
arbitrarily required perfect substitutability.
Non-price competition through product differentiation is often an essential
component of competition within a product market. See generally IIB Areeda &
Hovenkamp, ¶ 563a at 383–84 (“Many machines performing the same function—
such as copiers, computers, or automobiles—differ not only in brand name but also
in performance, physical appearance, size, capacity, cost, price, reliability, ease of
use, service, customer support, and other features. Nevertheless, they generally
compete with one another sufficiently that the price of one brand is greatly
constrained by the price of others.”). As a basic example, Coca-Cola and Pepsi are
plainly competitors even though they offer products with somewhat different
content. See E.I. du Pont, 351 U.S. at 393 (“[T]here are certain differences in the
formulae for soft drinks but one can hardly say that each one is an illegal
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monopoly.”); accord Green Cty. Food Market, Inc. v. Bottling Group, LLC, 371
F.3d 1275, 1283 (10th Cir. 2004) (“Pepsi branded beverage products cannot alone
comprise a relevant product market,” even if consumers are “brand loyal” to Pepsi
products); Barq's Inc. v. Barq's Beverages, Inc., 677 F. Supp. 449, 455 (E.D. La.
1987) (“Based upon the theory of interchangeability, . . . Barq's root beer is merely
one soft drink in a market of competing soft drinks.”). And television networks
fiercely compete with each other despite offering very different programming.
E.g., Levitch, 649 F. Supp. at 667.
Distributors of entertainment content use product differentiation to compete
with each other. In an effort to distinguish its services from its rivals’ services in a
way that will appeal to consumers, a content provider must decide what (and how
much) content to obtain and make available, and must also decide the method by
which to make that content available. See Netflix 2013 Annual Report at 3 (“Our
ability to continue to attract members” depends on “our ability to consistently
provide our members with a valuable and quality experience for selecting and
viewing TV shows and movies,” as well the “relative service levels, content
offerings, pricing and related features of competitors to our service”). Content and
delivery method, in essence, are tools that content providers use to increase their
share of the digital-entertainment market.
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But the Commission’s analysis suggests that the fact that a provider engages
in non-price competition with other firms is enough to place those other firms in a
different product market. That makes no sense and is not the law. That firms
make different choices, and offer different (although usually significantly
overlapping) inventories of titles, does not itself imply – let alone require – that the
services are in different markets. See, e.g., Continental Can Co., 378 U.S. at 45256 (glass and metal containers are “interchangeable” and are in same market
despite “distinctive characteristics,” despite fact that “competition” is not limited to
price competition, and despite fact that demand for one type of container “is not
particularly or immediately responsive to changes in the price of the other”). If it
did, then every firm would have a monopoly over its own differentiated product.
See Eastman Kodak v. Image Tech. Servs., 504 U.S. 451, 481–82 (1992) (only in
“rare circumstances” will a single brand of a service constitute its own product
market); PSKS, Inc. v. Leegin Creative Leather Prods., 615 F.3d 412, 418 (5th Cir.
2010) (firm’s products constitute their own market only where the firm’s
“consumers are ‘locked in’ to a specific brand by the nature of the product”); TV
Communications Network, Inc. v. Turner Network Television, Inc., 964 F.2d 1022,
1025 (10th Cir. 1992) (rejecting proposed relevant market consisting of a single
television channel).
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In short, the Commission’s analysis falsely equates product differentiation
with different product markets. Two products are differentiated where consumers
perceive a difference between them. Those products are in the same market where
consumers view them as reasonably interchangeable substitutes despite the
perceived differences. By conflating the two concepts, the Commission – despite
purporting to define the market based on reasonable substitutability – improperly
required products to be identical in order to be sufficiently close competitors.
2.
The Commission’s Analysis of “Limitations” Preventing
Other Firms From Offering Identical Content is Limited
and Flawed.
In any event, the Commission’s analysis of the “limitations” of other
delivery channels is incomplete and cursory. Most of the Commission’s discussion
is in reference to electronic delivery methods (i.e., streaming and downloading),
and most of that discussion is focused on video games rather than movies,
television shows, and similar entertainment. 4
As an initial matter, the Commission does not attempt to reconcile the
tension between its conclusion that technical “limitations” preclude streaming and
4
See JA585 (noting various “commercial practices” by copyright owners
concerning video games, and “[t]echnical limitations” that are “particularly
problematic for streaming of video games”); JA586-87 (evaluating evidence
“regarding the technical ability to stream or download video games”); JA588
(noting testimony that “numerous unresolved technical problems” will impair “the
practical ability to delivery digital content, particularly more sophisticated digital
games”); JA589 (“technological problems” render it “uncertain” that digital access
to video games is a reasonable substitute for DVDs-by-mail).
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downloading of video games from being a reasonable substitute for video-game
DVDs and its citation of a report predicting that, by 2017, digital distribution of
video games could grow to 66 percent of the video-game market. JA589. If digital
distribution of games could dominate the video-game industry within three years,
then it is hard to imagine that it does not even compete in the same market as game
DVDs now. Nor does the Commission address similar evidence in the record, such
as the fact that spending on digital distribution of games grew 16 percent in 2012
alone while spending on physical distribution declined 21 percent, JA144, or that
GameFly’s DVD-by-mail volumes (and thus all DVD-by-mail volume for video
games) declined by 29 percent between 2011 and 2013.
JA172.
If digital
distribution of games were such an inadequate substitute for DVD-by-mail service,
the Commission should have at least analyzed why DVD-by-mail customers are
leaving and where they are going.
Moreover, the Commission’s decision to focus primarily on video games
rather than movies is misplaced. Even if technical limitations preclude widespread
streaming or downloading of video games, and even if such limitations were
somehow sufficient to make GameFly’s customers captive to GameFly’s service,
that alone would not give the Postal Service market power to raise the price of the
postage that GameFly uses to deliver video games to its customers. As noted
above, roughly 98 percent of the overall consumer demand for the mail delivery of
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DVDs is the demand for Netflix’s offerings rather than GameFly’s. Because the
Postal Service is required to charge the same price for delivering GameFly’s DVDs
as it charges for Netflix’s DVDs, see GameFly II, 747 F.3d 906, it cannot price
discriminate between the two firms’ services. Accordingly, even if GameFly’s
DVD-by-mail service does not face competition from other delivery channels,
GameFly’s customers (and, derivatively, GameFly itself) are protected from price
increases so long as Netflix’s customers view alternatives to DVD-by-mail service
as reasonably interchangeable substitutes.
See Menasha Corp. v. News Am.
Marketing In-Store, Inc. 354 F.3d 661, 665 (7th Cir. 2004) (Easterbrook, J.)
(noting, as an example, that makers of low-calorie soft drinks could not raise their
prices simply because diabetics, a segment of their customer base, are “locked in”
to low-calorie drinks; because non-diabetics could switch to other products, they
“protect” the locked-in customers).
The focus of the product-market inquiry
should be on movies, television shows, and the related content that Netflix
provides, not on video games.
The Commission’s analysis of alternatives to the mail delivery of movies
and similar content is sparse. It points to no technological limitations precluding
movies from being streamed or downloaded to the same extent as they are
delivered through the mail. It relies instead principally on a commercial limitation
– the fact that content creators and other copyright owners, by virtue of the “first-
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sale” doctrine,5 have leverage over digital distribution that they lack over physical
distribution – to defend the counterintuitive proposition that streaming is not an
adequate substitute for physical DVD rentals. But that points back to the nature of
the competition between firms that provide access to movies. There are several
dimensions on which firms compete – price, content, and method of distribution.
That some content may be more expensive to acquire than others is a reality faced
by all content providers, and is hardly unique to those providers who use digital
distribution as the channel for distributing content to their customers.
And even if the commercial limitation identified by the Commission places
services providing movies by electronic means in a different market from services
providing movies on physical DVDs, that does not explain the exclusion of other
delivery methods – namely, kiosks, retail locations, and DVD sales – as reasonable
substitutes for DVD-by-mail delivery. Even under the Commission’s analysis, the
purchase of DVDs from an online retailer like Amazon.com, which uses a physical
delivery channel (but does not use the mail exclusively to deliver the content)
would seem to be an obvious substitute for DVD-by-mail.
The Commission
brushed aside the substitutability of DVD sales, concluding that the “record is
inconclusive,” JA593, but its skepticism was based entirely on the “high cost” – as
5
Under the “first-sale” doctrine, the sale of a physical copy of a copyrighted work
extinguishes the copyright owner’s exclusive distribution right, freeing the buyer to
sell that copy without restriction. 17 U.S.C. § 109.
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much as $60 – of “new video game DVDs.” JA593. Again, the Commission
incorrectly focused on video games rather than movies.
The Commission’s exclusion of physical outlets, particularly Redbox kiosks,
from the market is particularly unjustified considering that (1) Redbox is in the
business of renting physical DVDs, and thus is not burdened with the technological
or commercial limitations that the Commission deemed so important in evaluating
potential substitutes for DVD-by-mail service; and (2) as the Commission itself
acknowledged, Redbox rents far more physical DVDs than Netflix does. JA591.6
In fact, it is undisputed that, as of 2013, Redbox accounted for more than 45
percent of all DVD rentals (including both movies and games), with Netflix
running far behind at 24 percent.
SA626.
Setting aside all other delivery
channels, including Redbox in the relevant market, would alone have been
sufficient to defeat a finding of market power on the part of the Postal Service.
And the kiosk channel should have been included – the Commission acknowledged
that Netflix’s DVD-by-mail service competed with earlier generations of physical
DVD rental outlets, JA594, so it should follow that the next generation of physical
rental outlets, kiosks, in turn compete with DVD-by-mail service.
While GameFly maintained that kiosk-based rental of video games was not an
“economically viable” method of providing access to video games, JA590, the
Commission acknowledged that Redbox rents more video games though its kiosks
than GameFly does through its DVD-by-mail service. JA591.
6
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The Commission’s exclusion of kiosks revisits its “differences in inventory”
point – that kiosks have “limited physical capacity,” JA591, and therefore do not
offer “consumers access to the broad range of DVD titles offered by Netflix and
GameFly through the mail.”
JA592.
But there is no inherent limitation on
Redbox’s ability to expand capacity – there just appears to be no competitive need.
Given that Redbox rents far more DVDs than Netflix and GameFly, its decision to
curate its content and offer only the movies and games that consumers want (as
opposed to amassing a collection of movies and games that most consumers do not
want) is a sign of effective competition rather than the absence of competition. The
fact that Redbox’s model is targeted carefully to consumer demand should not
exclude it from the DVD rental market.
C.
The Commission’s Finding that a “Core Group” of Customers
Prefer DVD-By-Mail Service Does Not Justify Its Conclusion that
DVD-By-Mail Service is in a Separate Product Market.
Even if having different inventories (or using different delivery channels)
does not prevent other entertainment-access services from competing in the same
market with DVD-by-mail service, the Commission next concluded that there is, in
essence, a submarket – a “core group of consumers of digital content” who
“perceive DVDs-by-mail as a separate product market” and for whom “there are
no reasonably available economic substitutes.” JA604. Because those customers
“prefer or require DVDs-by-mail service to consume certain video content,” the
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Commission reasoned, they are in effect captive customers of Netflix or GameFly
and thus would not switch to other services in response to a price increase. JA581;
accord JA596-97 (agreeing with GameFly that “there is a core group of customers
who rent entertainment and video game DVDs-by-mail, and do not regard such
content available by Internet streaming, downloading, kiosks, or retail purchases to
be adequate substitutes” because of the “limitations” on the titles available from
those other distribution channels).
Accordingly, the Commission concluded,
DVD-by-mail service is a separate product market for that group of customers.
The Supreme Court has allowed that, within a product market, “well-defined
submarkets may exist which, in themselves, constitute product markets for antitrust
purposes.” Brown Shoe, 370 U.S. at 325; accord U.S. v. Grinnell Corp., 384 U.S.
563, 574 (1966) (when a firm distinguishes itself by offering a particular package
of goods or services, there may exist a core group of consumers for whom “only
[that package] will do.”). Identifying such a submarket is fact-intensive and calls
for an examination of several “practical indicia” such as “industry or public
recognition of the submarket as a separate economic entity, the product’s peculiar
characteristics and uses, unique production facilities, distinct customers, distinct
prices, sensitivity to price changes, and specialized vendors.” Brown Shoe, 370
U.S. at 325. But the Commission’s analysis is nothing but a series of tautologies
masquerading as factual findings.
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The Commission’s principal hypothesis appears to be that all customers who
still use DVD-by-mail must do so because they view alternative services as
unreasonable substitutes and thus must constitute the “core group of consumers of
digital content” for whom DVDs-by-mail is a distinct product market. JA604.7
But that proposition proves far too much. If the fact that a customer uses a given
product means that the customer views no other product as a reasonable substitute,
then there could never be market of competing products – every single firm would
have monopoly power over the product it provides to its existing customers, even
if it has lost most of its customers to competitors, and will retain that monopoly
power until its final customer stops using the firm’s service.
This myopic
conception of a product market is inconsistent with governing principles of
antitrust law. See Neumann v. Reinforced Earth Co., 786 F.2d 424, 429 (D.C. Cir.
1986) (“It makes no sense [to demonstrate] monopoly power by defining the
market as those customers whom the entrant has . . . managed to persuade.”);
Queen City Pizza, Inc. v. Domino’s Pizza, Inc., 124 F.3d 430, 438 (3d Cir. 1997)
7
See JA597 (existence of a core group of DVD-by-mail customers “is confirmed
by the fact that consumers continue to pay Netflix, GameFly, and other companies
for the right to receive rented DVDs-by-mail”); JA581(accepting Netflix’s and
GameFly’s argument that “there are no close substitutes for round-trip DVD
mailers to serve their customers now using that service,” because those customers
“either prefer or require DVDs-by-mail service to consume certain video content”);
JA579-80 (accepting argument that, because “large numbers of consumers will
continue to demand DVD-by-mail rental” for the foreseeable future, DVD-by-mail
rental will continue to be a “distinct product market[]”) (citations omitted).
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(“The test for a relevant market is not commodities reasonably interchangeable by
a particular plaintiff, but ‘commodities reasonably interchangeable by consumers
for the same purposes.’”). The bare fact that a firm has customers does not itself
suggest that those customers believe that they lack alternatives.
Nor does the fact that both Netflix and GameFly have a large inventory of
content support the inference that their subscribers would accept only the precise
inventory that those companies offer. The Commission points to no evidence that
Netflix’s and GameFly’s remaining DVD-by-mail customers mostly eschew the
titles that are available through other distribution methods and instead consume the
obscure and idiosyncratic titles that only GameFly and Netflix provide. If that
were the case, the number of such customers would not be declining, let alone at
such an alarming rate. But Netflix’s most recent SEC filing freely admits that
“[t]he number of memberships to our DVD-by-mail offering is declining, and we
anticipate that this decline will continue.” Netflix 2014 Annual Report at 10.
It may be that some of Netflix’s or GameFly’s current DVD-by-mail
customers strongly prefer DVD-by-mail service over other services that provide
access to movies or games. As the First Circuit observed, “virtually every seller of
a branded product has some customers who especially prefer its product.”
Grappone, Inc. v. Subaru of N.E., Inc., 858 F.2d 792, 797 (1st Cir. 1988). The fact
that some customers may “prefer” movies available exclusively by DVD-by-mail
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to movies available through other distribution channels is not enough to show that
such alternatives are not reasonably interchangeable and therefore are in a separate
market, even for those consumers. Brokerage Concepts, Inc. v. U.S. Healthcare,
Inc., 140 F.3d 494, 513 (3d Cir. 1998) (“Interchangeability implies that one
product is roughly equivalent to another for the use to which it is put; while there
might be some degree of preference for the one over the other, either would work
effectively.”) (citation omitted). Creating such preferences is, after all, the purpose
of product differentiation. See IIB Areeda & Hovenkamp, ¶ 563a at 383 (product
differentiation describes non-price differences that at least some buyers value or
favor).
The existence of unusually loyal customers is relevant to the market
definition when it permits a company to exploit that loyalty. For example, if the
group of unusually loyal customers is particularly large, it may allow a firm to
raise prices to a supracompetitive level because the revenue generated from the
higher prices paid by its “core” customers will exceed the revenue lost from the
departure of its marginal customers.
See Menasha Corp., 354 F.3d at 665;
Grappone, 858 F.2d at 796 (noting that “sellers typically set fairly uniform prices
designed to attract a large number of buyers, not simply a handful of buyers who
have some unusual and special preference for its products”). Or, if a firm could
identify its loyal (“core”) customers (over whom it has monopoly power) and
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distinguish them from the firm’s marginal customers (over whom it does not), it
could engage in price discrimination by charging higher prices to the former group.
See IIB Areeda & Hovenkamp, ¶ 534 at 270 (often, “the seller who can segregate a
substantial group of buyers and charge them monopoly prices for a significant
period of time has market power over the group of buyers who pay these prices,”
even if the seller lacks such power over all purchasers in the market); cf. In re
Brand Name Prescription Drugs Antitrust Litig., 123 F.3d 599, 603 (7th Cir. 1997)
(Posner, J) (“presence of price discrimination” is evidence that “competition must
be weak or absent”).
This Court’s decision in FTC v. Whole Foods Market, Inc., 548 F.3d 1028
(D.C. Cir. 2008), on which the Commission’s “core customers” discussion
principally relies, demonstrates the inadequacy of the Commission’s analysis.
Whole Foods did not produce a majority opinion, but two judges concluded that
the FTC had presented evidence sufficient to present a substantial question
concerning whether there was a product market of “premium natural and organic
supermarkets” separate from supermarkets generally, 548 F.3d at 1041 (opinion of
Brown, J.); id. at 1047 (opinion of Tatel, J.), and that the district court erred in
focusing exclusively on organic supermarkets’ “marginal customers.”
Only Judge Brown’s opinion discussed the extent to which “core customers”
– i.e., “distinct customers, paying distinct prices,” 548 F.3d at 1039 (opinion of
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Brown, J.) (citation omitted) – informed the market-definition analysis, and
nothing in that opinion suggests that the mere existence of “core customers” was
sufficient to imply that organic supermarkets constituted a market distinct from
supermarkets generally.
Instead, Judge Brown’s and Judge Tatel’s opinions
suggest that, where there is evidence that a group of customers is both large
enough and loyal enough to permit a firm to engage in price discrimination or to
profitably raise prices to supracompetitive levels, then it may be appropriate to
define a relevant market from the perspective of those loyal customers. Both
Judge Brown and Judge Tatel relied on evidence that (1) organic supermarkets
engaged in price discrimination between “core” customers and “marginal”
customers in geographic markets where there were no other organic supermarkets,
id. at 1039-40 (opinion of Brown, J.); id. at 1046-47 (opinion of Tatel, J.); and (2)
“core customers” formed the majority of Whole Foods’ customer base and
provided the bulk of organic supermarkets’ business. Id. at 1040-41 (opinion of
Brown, J.); id. at 1049 (opinion of Tatel, J.)
Here, the Commission’s order relies on no evidence suggesting that Netflix
or GameFly has been able to quantify its “core” DVD-by-mail customers or
distinguish them from its “marginal” customers, has been able to profitably charge
supracompetitive prices, or has engaged or is able to engage in price discrimination
against its most loyal customers. And, even if those firms had that ability over
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their customers, the Postal Service would not have the ability to replicate such an
analysis and could not use it as the basis for price discrimination.
The only actual evidence that the Commission cites in support of its “core
customer” hypothesis is that some of Netflix’s customers pay for both streaming
and DVD-by-mail, JA597, suggesting to the Commission that they must “view
DVDs-by-mail as a separate product market.” JA599. That makes no sense. First,
the number of such customers is relatively low – more than 80 percent of Netflix’s
customers use either its streaming service or its DVD-by-mail service, but not
both, with the ratio tilted overwhelmingly toward streaming only. SA746. Second,
the fact that some customers pay for both services shows, at most, that they
recognize Netflix’s DVD-by-mail service and Netflix’s streaming service as
having different product attributes (e.g., overlapping but not identical content). It
does not suggest that such customers view the two services as being part of
separate product markets.
D.
The Commission’s Discussion of the Views of Industry
Participants Does Not Actually Discuss the Industry Participants’
Views on Who Their Competitors Are.
Finally, the Commission found that “industry participants,” i.e., firms that
provide access to digital entertainment such as movies and games, “perceive
DVDs-by-mail to be a separate product market.” JA604. The views of industry
participants on whom their competitors are, while not dispositive, are can shed
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some light on the interchangeability of the products they offer.
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See, e.g.,
Continental Can Co., 378 U.S. at 453-55. However, the evidence cited by the
Commission does not support its conclusion “that industry participants currently
perceive DVDs-by-mail to constitute a separate and distinct product market.”
JA602-03.
In its four-page discussion of the issue, JA599-603, the Commission relied
on two categories of evidence. First, it cited three statements attributed to Netflix:
(1) that its DVD-distribution business and its streaming business are different
product lines operated out of corporate divisions using different personnel; (2) that
it expects its DVD-distribution business to “continue to operate for the foreseeable
future”; and (3) that its decision to invest more heavily in streaming than in DVD
distribution does not prove that it intends to “slight” the latter. JA600-01. None of
these statements says anything about who Netflix’s competitors are or whether
other content providers utilizing distribution channels other than mail delivery
compete with Netflix’s DVD-by-mail service. Second, the Commission rehashed
observations made earlier in its order about the alleged technical limitations of
digital distribution of video games and the fact that not literally every movie or
game available by DVD delivery is presently available through other channels.
JA601-02.
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At the same time, the Commission gave scant attention to the question it was
purporting to answer: who do industry participants think their competitors are?
On that question, Netflix’s report to the SEC at the end of 2013 stated:
The market for entertainment video is intensely competitive and
subject to rapid change. Many consumers maintain simultaneous
relationships with multiple entertainment video providers and can
easily shift spending from one provider to another. Our principal
competitors vary by geographic region and include multichannel
video programming distributors providing free on demand content
through authenticated Internet applications, Internet-based movie and
TV content providers, including both those that provide legal and
illegal (or pirated) entertainment video content, DVD rental outlets
and kiosk services and entertainment video retail stores.
Netflix 2013 Annual Report at 2; see also id. at 3 (noting that “new and existing
distribution channels” afford consumers “various means for consuming
entertainment video” and such channels can potentially “capture meaningful
segments of the entertainment video market.”).
GameFly stipulated in earlier Commission proceedings that “GameFly
competes with other DVD video game by mail rental companies with similar
business models (e.g., Gamerang and GottaPlay); weekly rental companies (e.g.,
Blockbuster and Hollywood); and sell-through vendors (e.g., GameStop, Best Buy,
Target and Toys R Us).” Joint Statement of Undisputed and Disputed Facts, PRC
Docket No. C2009-1, at 3 (P.R.C. filed July 20, 2009), available at
http://tinyurl.com/k469a9k. Similarly, in a registration statement filed with the
SEC in September 2010, GameFly acknowledged that its service competed against
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“large retailers, such as Amazon, eBay, Blockbuster, Best Buy, GameStop, Target
and Walmart, and other competitors that offer video game sales or rentals through
retail stores, online or both”; and further that “alternative channels for online
entertainment” are “growing in popularity” and “new technologies for delivery of
in-home video game entertainment, such as Internet delivery of video game
content, continue to receive considerable media and investor attention.” GameFly,
Inc., Amendment 5 to Registration Statement (Form S-1), at 11, available at
http://tinyurl.com/lrkf5pt.
Finally, Outerwall, whose Redbox kiosks rent more physical DVDs than
Netflix and GameFly combined, has stated that it “faces competition from many
other providers, including those using other distribution channels,” such as: “maildelivery and online retailers, like Netflix or Amazon”; “cable, satellite, and
telecommunications providers, like Comcast or DISH Network”; “other forms of
movie content providers like Internet sites including iTunes, YouTube, Hulu or
Google”; “traditional brick and mortar video retailers”; and “other forms of video
game rental providers, like GameFly.” Outerwall 2013 Annual Report at 3.
Despite purporting to evaluate the views of industry participants, the
Commission’s order barely mentioned their views on the nature of the competition
they face or who their competitors are.
For this reason, the Commission’s
evaluation of this factor is wholly arbitrary and capricious.
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*
For the reasons set forth above, the Commission’s conclusion that the
relevant market is limited to “physical delivery of rented videos and games via a
DVD mailer” is based on a misapplication of the antitrust principles on which it
purported to rely and on findings that do not support the conclusion it reached.
Accordingly, its conclusion concerning the scope of the relevant market is arbitrary
and capricious.
This Court need not go further than that to reverse the
Commission’s decision, because the Commission’s order conceded that it never
considered whether the Postal Service has market power if the market were defined
to include methods of distributing digital entertainment content other than DVDby-mail service. JA607 at n.33.
III.
EVEN IF THE COMMISSION’S MARKET DEFINITION WERE
NOT ERRONEOUS, IT STILL ERRED IN ASSESSING WHETHER
THE POSTAL SERVICE HAD “MARKET POWER” WITHIN THE
MEANING OF 39 U.S.C. § 3642(b)(1).
Even if the Commission were somehow correct that the relevant market is
limited to rentals of entertainment DVDs that are delivered by mail, that does not
lead inexorably to the conclusion that the Postal Service has “market power.”
Under 39 U.S.C. § 3642(b)(1), “market power” refers to a firm’s ability to raise
prices without a risk of losing a substantial amount of business.
And the
Commission arbitrarily failed to consider important limitations on the ability of the
Postal Service to raise prices in the DVD-by-mail “market.”
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The Commission’s Three Findings Shed Little Light on Whether
the Postal Service Has Market Power Over DVD-By-Mail Service.
The Commission’s analysis of the Postal Service’s market power consists of
three observations: (1) the Postal Service failed to present elasticity data showing
that the demand for the Round-Trip Mailer would decrease if its price were
increased, JA608-10; (2) the Round-Trip Mailer would have “high cost
coverages,” JA610; and (3) the Postal Service once had “demonstrated pricing
power” over GameFly. JA610. The first two points are of limited value and the
third is completely irrelevant.
Price elasticity data does not exist for the proposed Round-Trip Mailer
product.
However, as the Commission conceded, it has never required the
submission of price elasticity data in order to determine whether a proposed
product should be deemed competitive or “market dominant” within the meaning
of 39 U.S.C. § 3642. JA608. While the absence of elasticity data prevents the
Postal Service from using such data to prove that it lacks market power – for
example, by showing that a price increase caused rather than coexisted with a
reduction in demand for a product – the absence of such data does not itself
indicate the presence of market power.
Regarding the supposed “high cost coverages” of the Round-Trip Mailer
product, referring to the extent to which the Postal Service’s prices exceed the
“attributable” costs of selling the product, several products are classified as
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“competitive” despite considerably exceeding their “attributable” costs.
See
Analysis of USPS Financial Results and 10-K Statement for FY 2013, at 43 (P.R.C.
Mar. 18, 2014), available at http://www.tinyurl.com/prc20140318 (Priority Mail
Express covered 189.2 percent). This is not surprising. The Postal Service’s fixed,
“institutional” costs are high and growing, and help explain why the Postal Service
has not turned a profit since 2007. See id. at 23-24 (institutional costs have risen
more than 6 percent since 2007, and are likely to rise as a share of total costs); id.
at ii (“the Postal Service’s current financial situation,” including the $46.2 billion
net deficit amassed since 2007, “calls into question its long-term viability”).
Accordingly, the fact that the proposed Round-Trip Mailer would exceed its
attributable costs is essentially meaningless. See U.S. v. Eastman Kodak Co., 63
F.3d 95, 109 (2d Cir. 1995) (“Certain deviations between marginal cost and price,
such as those resulting from high fixed costs, are not evidence of market power.”);
In re Wireless Tel. Servs. Antitrust Litig., 385 F. Supp. 2d 403, 422 (S.D.N.Y.
2005) (“[T]he test for the existence of market power is the ability to control price
or exclude competition, not simply pricing a product above marginal cost when
that price differential can be explained by the existence of economic realities
entirely separate from the existence of market power, for instance, the presence of
high fixed costs.”) (citation omitted); cf. IIB Areeda & Hovenkamp, ¶ 516g at 14849 (a firm pricing above marginal cost will not necessarily bring excess return on
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investment, particularly where capital expenditures and similar costs not closely
based on output are high).
Finally, the Commission’s observation about the history of “demonstrated
pricing power” that the Postal Service exercised over GameFly, JA610, is
inapposite. As the Commission conceded, such pricing power – i.e., offering
favorable terms of service to Netflix but not GameFly, thus requiring GameFly “to
pay almost double per piece what it currently pays for sending round-trip DVDsby-mail,” JA610 – ceased in “2013, when rate relief was imposed by the
Commission.” Id. As a result of that relief, the Postal Service must charge the
same price to GameFly as it charges to Netflix, even if GameFly’s mailpieces
consistently cost the Postal Service more to process. Accordingly, the Postal
Service cannot be said to have any particular pricing power over GameFly.
B.
The Commission Arbitrarily Ignored Factors Bearing on
Whether the Postal Service Has Sufficient “Market Power.”
At the same time the Commission relied on facts bearing (at most) only
marginally on whether the Postal Service has sufficient market power, it ignored
factors tending to show that such power is absent.
First and foremost, while it discussed the Postal Service’s historical pricing
power over GameFly, it wholly ignored its own previous conclusions suggesting
that Netflix had countervailing power over the Postal Service. This is a significant
omission. As discussed above, almost all the revenue the Postal Service receives
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from shipments of round-trip DVDs comes from Netflix’s DVD-by-mail service.
Even if one were to assume (incorrectly, as argued above) that there are no
reasonable substitutes for the DVD-by-mail service that Netflix provides, that itself
would give the Postal Service market power over Netflix only if Netflix were a
pure price taker, forced to accept whatever price the Postal Service sets.
The earlier Commission proceedings that gave rise to this proceeding were
premised on Netflix’s unique buying power. Specifically, GameFly argued that,
acceding to Netflix’s demands as a large and powerful customer, the Postal Service
gave Netflix special treatment (including special processing and waiver of
surcharges) – even though such favoritism increased the Postal Service’s costs –
but would not do the same for GameFly. 8
Netflix argued that the differing
treatment was justified, but added that, if the Commission afforded GameFly a
remedy that impacted Netflix’s operations, that “decision would likely result in
reduced DVD shipment growth from Netflix as well as accelerate the ultimate
decline of DVD shipments as Netflix would shift more resource[s] to the digital
8
See, e.g., Posthearing Brief of GameFly, Inc., Docket No. C2009-1, at 1 (P.R.C.
filed Nov. 8, 2010) (“This case is about the caste system that the Postal Service
maintains among its customers in the DVD rental industry.”), available at
http://tinyurl.com/qdo45jj; id. at 50 (“Confronted with Netflix’s resistance” to
making mailpieces machinable or paying non-machinable surcharge, “Postal
Service management has consistently backed down.”); Reply Post-Hearing Brief of
GameFly, Inc., Docket No. C2009-1, at 33 (P.R.C. filed Nov. 29, 2010) (“Only a
desire to cater to Netflix can explain” preferences that the Postal Service “offered
to Netflix but withholds . . . from other DVD rental companies.”), available at
http://tinyurl.com/qb8zfvy.
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delivery of content.” Comments of Netflix on GameFly, Inc., Motion to Compel,
Docket No. C2009-1, at 2 (P.R.C. filed Aug. 30, 2010), available at
http://tinyurl.com/n65brjj. The Commission held that, in fact, the Postal Service
had given Netflix preferential pricing (by waiving the non-machinable surcharge
for its DVD mail) and its practice of manually processing Netflix’s mail (for free)
had increased the Postal Service’s costs. Order No. 718, supra, at 90, 96. Giving
away free services and incurring additional costs are not the actions of an entity
with market power, and yet the Commission failed to even consider in this
proceeding whether Netflix’s countervailing buying power would prevent the
Postal Service from holding market power over Netflix.
Another significant omission is the impact of technological change on the
durability of any market power that a given distribution channel (including mail
delivery) may have. See IIB Areeda & Hovenkamp, ¶ 502 at 110-11 (the ability to
reap supracompetitive prices and profits “does not exclude competition but attracts
it,” and thus does not alone establish market power unless it is durable, i.e., unless
the firm also has the ability to exclude competition); id. ¶ 506 at 128 (“[T]ransitory
power may safely be ignored by antitrust law. . . . Moreover, such short-lived
supracompetitive pricing may legitimately reward [a firm] for desirable
innovations.”). There is no doubt that, whether consumer access to movies and
video games is sorted by distribution channels into separate markets or treated as a
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broader market, it is dynamic and rapidly evolving, with new delivery techniques
and distribution methods challenging incumbent methods for primacy.
The
Commission recognized this phenomenon when it noted that Netflix’s DVDs-bymail service caused the demise of the Blockbuster retail-store model. JA594. And
there can be no serious doubt that digital distribution of entertainment content is in
the process of supplanting physical (including DVD-by-mail) distribution.
Forestalling the flight from the mail-based delivery channel is an incredibly
powerful incentive for the Postal Service to keep DVD-mailing prices as low as
possible.
This Court has recognized that “[r]apid technological change leads to
markets in which firms compete through innovation for temporary market
dominance, from which they may be displaced by the next wave of product
advancements.” United States v. Microsoft Corp., 253 F.3d 34, 49 (D.C. Cir.
2001) (internal quotation omitted). Such change is inevitable in a dynamic and
rapidly evolving industry, strongly suggesting that any temporary “market power”
enjoyed by a firm using a particular distribution channel – and, by extension, by an
entity who supplies an input to that firm – cannot sustain any pricing power for
long, and charging supracompetitive prices will only hasten the demise of a
temporarily “powerful” channel. The Commission refused to even consider this
issue, JA604, and implicitly rejected it when it held that only “intramodal” systems
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(i.e., delivery channels technologically identical to mail delivery) are relevant to
the market-power inquiry. JA607-08.
CONCLUSION
For the reasons stated above, this Court should grant the petition for review
and remand the matter to the Commission for further proceedings.
Dated: May 4, 2015
Respectfully submitted,
THOMAS J. MARSHALL
Executive Vice President & General Counsel
R. ANDREW GERMAN
Managing Counsel
/s/ David C. Belt
DAVID C. BELT
Office of the General Counsel
United States Postal Service
475 L’Enfant Plaza, SW
Washington, DC 20260
(202) 268-2945
[email protected]
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CERTIFICATE OF COMPLIANCE
I hereby certify, pursuant to Fed. R. App. P. 32(a)(7), that the foregoing
Brief of the United States Postal Service uses proportionately spaced, 14-point
type, and contains 13,688 words as measured by Microsoft Word, a word
processing system that includes footnotes and citations in word counts.
/s/ David C. Belt
Attorney for the U.S. Postal Service
Dated: May 4, 2015
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CERTIFICATE OF SERVICE
I hereby certify that on May 4, 2015, the foregoing brief was electronically
filed with the U.S. Court of Appeals for the District of Columbia Circuit by using
the CM/ECF system. I further certify that counsel for the respondent and the
intervenor are registered as ECF filers and that they will be served by the CM/ECF
system.
/s/ David C. Belt
DAVID C. BELT
Office of the General Counsel
United States Postal Service
475 L’Enfant Plaza, SW
Washington, DC 20260
(202) 268-2945
[email protected]
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STATUTORY ADDENDUM
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TABLE OF CONTENTS
Page
39 U.S.C. § 102(8)-(9) ...................................................................................... Add. 1
39 U.S.C. § 3621(a) .......................................................................................... Add. 1
39 U.S.C. § 3631(a) .......................................................................................... Add. 2
39 U.S.C. § 3642(a)-(b) .................................................................................... Add. 3
39 U.S.C. § 3663 ............................................................................................... Add. 4
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TITLE 39—POSTAL SERVICE
PART I—GENERAL
CHAPTER 1—POSTAL POLICY AND DEFINITIONS
***
§ 102. Definitions
As used in this title—
***
(8) “market-dominant product” or “product in the market-dominant category of
mail” means a product subject to subchapter I of chapter 36;
(9) “competitive product” or “product in the competitive category of mail” means a
product subject to subchapter II of chapter 36;
***
PART IV—MAIL MATTER
***
CHAPTER 36—POSTAL RATES, CLASSES, AND SERVICES
SUBCHAPTER I—PROVISIONS RELATING TO MARKET-DOMINANT
PRODUCTS
§ 3621. Applicability; definitions
(a) Applicability.—This subchapter shall apply with respect to—
(1) first-class mail letters and sealed parcels;
(2) first-class mail cards;
(3) periodicals;
(4) standard mail;
(5) single-piece parcel post;
(6) media mail;
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(7) bound printed matter;
(8) library mail;
(9) special services; and
(10) single-piece international mail,
subject to any changes the Postal Regulatory Commission may make under
section 3642.
***
SUBCHAPTER II—PROVISIONS RELATING TO COMPETITIVE
PRODUCTS
§3631. Applicability; definitions and updates
(a) Applicability.—This subchapter shall apply with respect to—
(1) priority mail;
(2) expedited mail;
(3) bulk parcel post;
(4) bulk international mail; and
(5) mailgrams;
subject to subsection (d) and any changes the Postal Regulatory Commission may
make under section 3642.
***
SUBCHAPTER III—PROVISIONS RELATING TO EXPERIMENTAL AND
NEW PRODUCTS
***
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§3642. New products and transfers of products between the market-dominant
and competitive categories of mail
(a) In General.—Upon request of the Postal Service or users of the mails, or upon
its own initiative, the Postal Regulatory Commission may change the list of
market-dominant products under section 3621 and the list of competitive products
under section 3631 by adding new products to the lists, removing products from
the lists, or transferring products between the lists.
(b) Criteria.—All determinations by the Postal Regulatory Commission under
subsection (a) shall be made in accordance with the following criteria:
(1) The market-dominant category of products shall consist of each product in
the sale of which the Postal Service exercises sufficient market power that it can
effectively set the price of such product substantially above costs, raise prices
significantly, decrease quality, or decrease output, without risk of losing a
significant level of business to other firms offering similar products. The
competitive category of products shall consist of all other products.
(2) Exclusion of products covered by postal monopoly.—A product covered by
the postal monopoly shall not be subject to transfer under this section from the
market-dominant category of mail. For purposes of the preceding sentence, the
term “product covered by the postal monopoly” means any product the
conveyance or transmission of which is reserved to the United States under
section 1696 of title 18, subject to the same exception as set forth in the last
sentence of section 409(e)(1).
(3) Additional considerations.—In making any decision under this section, due
regard shall be given to—
(A) the availability and nature of enterprises in the private sector engaged in
the delivery of the product involved;
(B) the views of those who use the product involved on the appropriateness of
the proposed action; and
(C) the likely impact of the proposed action on small business concerns
(within the meaning of section 3641(h)).
***
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SUBCHAPTER V—POSTAL SERVICES, COMPLAINTS, AND JUDICIAL
REVIEW
***
§3663. Appellate review
A person, including the Postal Service, adversely affected or aggrieved by a final
order or decision of the Postal Regulatory Commission may, within 30 days after
such order or decision becomes final, institute proceedings for review thereof by
filing a petition in the United States Court of Appeals for the District of
Columbia. The court shall review the order or decision in accordance with section
706 of title 5, and chapter 158 and section 2112 of title 28, on the basis of the
record before the Commission.
Add. 4