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DISTRIBUTION THE NEWSLETTER OF THE DISTRIBUTION AND FRANCHISING COMMITTEE

Antitrust Section — American Bar Association Vol. 15, No. 1 — January 2011

In this Issue

Message from the Chair ...... 1

Mobile Advertising: An Economic Perspective ...... 3

Recent Antitrust Issues in Distribution of ...... 9

Online Distribution in the EU: The New Rules on Vertical Restraints and their Implications for Internet Retailing Across the Atlantic ...... 12 Distribution and Franchising Committee:• ABA•Section of Antitrust Law

Recent Antitrust Issues in Distribution of DVDs Howard Marvel and Kivanc Kirgiz 1

Introduction continually attempting to protect their own window from being shortened, even as all but the first-release Motion picture studios have long supplied movies to theaters argue that the start date of their particular consumers through an elaborate system of distribution window should be moved earlier. “windows” in which consumers pay lower rates per viewing as the time from a movie’s initial release Traditionally, motion pictures were first released through increases. This system allows studios to charge different theaters, where the average price of admission was $7.85 prices to consumers through different distribution during the first three quarters of 2010. 2 Roughly four channels depending on their preferences for watching months after the theatrical release, the -release movies close to their release date. Such legal price window opened with movies being made available for discrimination permits the studios to maximize the value sale or rental in DVD or Blu-ray Disc format. Still later, of their copyrighted content and provides financial movies were released to video , “premium” incentives to produce and market new movies. cable channels, such as HBO, Showtime, and , and then to advertising-supported broadcast and cable The movie studios organize the window system through . Recently, this distribution window hierarchy a series of vertical contracts with various exhibitors and has been in flux as the movie studios have responded to distributors, doing so with the legal protection of their declining DVD sales, new distribution business models, . Thus an owner of a legal copy of a particular such as and , and technological advances movie, say one purchased in DVD format, cannot in the distribution of digital content, such as video-on- redistribute that movie to others, because that demand. Specifically, some movie studios have put redistribution represents the creation of an additional in place a delayed release window for online subscription copy, which the owner is permitted to halt. (Netflix) and kiosk rental companies (Redbox, Blockbuste r The price discrimination is a very old system, but one Express), where DVD and Blu-ray titles would be availabl e where the members of the distribution windows are through these outlets 28 days after their “street” date. At continually changing and the windows themselves are the same time, some movie studios are experimenting fought over bitterly. The firms in each window are with different windows for video-on-demand services,

1 Howard Marvel is Professor Emeritus at The Ohio State University and Kivanc Kirgiz is a Principal at Cornerstone Research. The views expressed in this paper are solely those of the authors and do not represent those of Cornerstone Research or any client. 2 Average ticket price up 3% on last year , THE HOLLYWOOD REPORTER, Oct. 29, 2010, available at http://www.hollywoodreporter.com/ news/average-ticket-price-3-last-33635.

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such as Time Warner’s plans to offer a premium video- their release. The cases settled after Redbox’s lawsuit on-demand service that will offer movies on pay against Universal, the first one filed, survived a motion television services shortly after their theatrical release to dismiss the antitrust allegations. 5 Although the court and ahead of their DVD release. 3 allowed Redbox’s case against Universal to proceed, we will argue that there is perhaps less here than meets the This note considers two examples of attempts to invoke eye. While the competitive impact of contractual vertical antitrust allegations as the players in the industry reacted restraints that extend the ability to price discriminate to developments in the movie distribution business. The beyond that afforded by copyright law requires case-by- first case involves movie studios’ decisions to institute a case examination, it is unlikely that any competitive new delayed release window for online subscription and harm has taken place in this case. kiosk rentals. Redbox, an operator of rental kiosks, has argued that Universal Studios (“Universal”), Warner The case against Netflix is still ongoing, 6 and Netflix’s (“Warner”), and Twentieth Century Fox burden will be to show that the fears it had expressed Home Entertainment (“Fox”), who have given up their about Wal-Mart as a potential competitor were proven copyright protection through the sale of movies on by the marketplace to have been unwarranted, and that discs, have tried to replace that protection with vertical its acquisition of Wal-Mart’s customer base was nothing distribution controls that violate the antitrust laws. 4 In more than a purchase of the assets of a failed competitor. the second case, Netflix and Wal-Mart are alleged to have Redbox’s lawsuits against Universal, Warner and Fox entered into an agreement to shape competition within Redbox has an innovative business model based on renting and across release windows through an agreement by DVDs through kiosks located at high-traffic locations “such which Wal-Mart left the “online DVD rental market,” as McDonald’s restaurants, Wal-Mart stores, grocery stores selling its subscriber-customers to Netflix. The such as Albertson’s, Kroger, Stop & Shop, Harris Teeter, and Netflix/Wal-Mart arrangement is alleged to be Meijer’s, convenience stores like 7-Eleven, drug stores such anticompetitive, as it supposedly constitutes horizontal as Walgreen’s, and Navy and Marine bases throughout the market division that impairs the functioning of one, continental and Puerto Rico.” 7 Since its and more recently two, exhibition windows. establishment in July 2002, Redbox rapidly expanded The disputes between Redbox and the three studios from two test markets and currently has kiosks at nearly have settled. The parties reached distribution agreements, 25,000 locations. It offers rentals of a limited number under which the studios provide DVDs and Blu-ray discs of individual titles for $1 per day, compared to the to Redbox at discounted prices but only allow Redbox $4.99-for-three-day rental fee that Blockbuster movie to rent DVD and Blu-ray discs starting four weeks after rental stores now charge for new releases. 8

3 Tom Lowry & Marc Graser, Time Warner ramps up premium VOD , VARIETY, Nov. 3, 2010, available at http://www.variety.com/article/VR1118026821. 4 Netflix negotiated agreements with movie studios, whereby it agreed to a delayed release window. Netflix did not file any lawsuits against the studios . 5 Warner and Fox signed distribution agreements with RedBox before the courts issued decisions on the pending motions to dismiss. 6 Currently a proposed settlement agreement with a maximum payment of $40 million between Wal-Mart and the plaintiffs is awaiting approval from the Court. Netflix remains as the lone defendant. 7 Amended Complaint ¶ 19, Redbox Automated , LLC v. Warner Home Video, Case No. 09-613 (D. Del. Nov. 30, 2009), ECF No. 1. 8 Eric Gruenwedel, Blockbuster Bows New In-Store Movie Pricing , HOME MEDIA MAGAZINE, Dec. 1, 2010, available at http://www.homemediamagazine.com/blockbuster/blockbuster-bows-new-store-movie-pricing-21294.

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According to most industry observers, the rapid growth Redbox would obviously prefer that its release window of Redbox and Netflix’s rental and video-on-demand open sooner, as that would increase its sales. This desire services have greatly contributed to the decline of DVD is no different from the preferences of other market sales and brick-and-mortar store rentals. Blockbuster, participants to improve their distribution windows. What the largest rental chain, is currently in bankruptcy is different is that Redbox’s window trails that for DVD reorganization. 9 and , sales. This matters because under copyright law’s “first which together comprised Blockbuster’s principal within- sale” doctrine, a DVD sold is very different from a DVD segment competition, have both ceased operations. 10 that is rented, at least so long as the content of the disc According to data from the Digital Entertainment is a movie rather than a sound recording or a computer Group, 11 DVD shipments to retail in U.S. and Canada program. With the sale of a DVD, the studio loses have declined by 27 percent between 2007 and 2009 control over the DVD it sells; under copyright laws, it after a 141 percent growth between 2002 and 2005 can only protect itself against unauthorized copying of the and flat sales between 2005 and 2007. DVD’s content, not the use of the product itself. As long as Redbox has purchased a legitimate DVD, it is to Facing declining revenue from DVD sales as well as rent that disc to multiple consumers. More importantly, higher priced brick-and-mortar store rentals, studios any other retailer or wholesaler who has purchased have responded by reorganizing their release windows. legitimate discs can resell those discs to Redbox for rental . At different times during 2008 and 2009, Universal, Fox, and Warner independently decided to create new delayed As part of their decisions to create a new delayed release windows for kiosk and online rental companies. release window for Redbox, Universal, Warner, and Fox Other studios, including Sony, Paramount, Disney, and announced that they wanted to deal directly with Redbox in contrast, decided to continue their policy and instructed their wholesale distributors, Ingram and of making their new release DVDs available to kiosk VPD, to stop selling the studios’ DVDs to Redbox on 12 and online rental companies on their street dates. In their release dates. Redbox has argued in its lawsuits that, response to Universal, Warner, and Fox’s independent stripped of copyright protection, the studios do not have decisions to create delayed release windows, Netflix and the ability to restrict sales to Redbox and accordingly that Blockbuster Express reached distribution agreements the three studios’ instructions to wholesale distributors with the studios in 2010. Redbox, on the other hand, run afoul of the antitrust laws. As Judge Kugler filed separate lawsuits against the three studios, arguing summarized in his opinion in the Universal case : among other things that the three studios have violated antitrust laws in their attempts to restrict Redbox from Plaintiff claims Universal demanded that Redbox sign obtaining DVDs on their street dates. the Revenue Sharing Agreement, an alleged restraint

9 See Blockbuster files for Chapter 11 bankruptcy, will reorganize , USATODAY, Sept. 23, 2010, available at http://www.usatoday.com/money/media/ 2010-09-23-blockbuster23_ST_N.htm. 10 Mike Spector & Peter Lattman, Hollywood Video Closes Doors , WALL STREET JOURNAL, May 3, 2010, available at http://online.wsj.com/ article/SB10001424052748704608104575220370429528864.html. 11 http://www.dvdinformation.com/. 12 For example, see Paramount And Redbox Extend Hook-Up , FORBES, June 16, 2010, available at http://www.forbes.com/2010/06/16/paramount- redbox-extend-partnership-marketnewsvideo.html. In 2009, Sony announced a new distribution agreement to provide new releases directly to Redbox, which did not involve a 28 day delayed window. Carl DiOrio, Sony-Redbox deal worth $460 million says filing , REUTERS, July 22, 2009, available at http://www.reuters.com/article/idUSTRE56K13320090722.

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on the supply and price of Universal DVDs. Further, high pricing scheme.” 15 That is, Redbox benefits from Plaintiff contends that when it refused to sign, the studios’ willingness to delay the opening of the Universal orchestrated a boycott of Redbox by Ingram, window that Redbox inhabits until Redbox and others VPD, and other distributors and retailers, including in that window have charged consumers for DVD and Wal-Mart. Redbox contends that viewings in that window. Redbox would not be as Universal induced those entities not to sell Universal profitable and may not even survive if the studios DVDs to Redbox, or risk themselves losing the released movies to cable and broadcast television at the opportunity to distribute or sell Universal DVDs. 13 same point that Redbox sales began. Indeed, were the studios unable to price discriminate at all, one might The economics of this complaint are thus straightforward. expect them to release movies simultaneously to Redbox accuses the studios of imposing non-price vertical theaters and to the home (through video-on-demand), restraints on the distributors of their movies. Redbox at least to the extent that they find themselves able to claims that this non-price vertical restraint is “a naked prevent theft of video streams. 16 restraint of trade that will decrease the supply of new- release DVDs in many, or all genres, reduce consumer In terms of potential antitrust implications, there is choice in various submarkets in the new-release DVD little concern with the possibility of concerted action by marketplace and artificially increase prices that consumers studios to set release windows parameters, since not all will have to pay to rent or buy new-release DVDs in studios go along with the restraints. In fact, Redbox does those submarkets, thereby negatively affecting consumer not allege any form of collusion among Universal, welfare.” 14 For the studios, the vertical restraints amount Warner, and Fox. to a competitive price discrimination mechanism based on Moreover, Redbox proposes a problematic market releasing their products at different time windows to take definition. Redbox asserts that “new-release DVDs” are advantage of consumers’ preferences for watching movies a relevant market, that each genre (i.e., action/adventure, close to their release date . comedy, etc.) constitutes a submarket within the overall Before discussing some of the potential antitrust issues new-release DVDs, and that every individual, copyrighted that these non-price vertical restrains may raise, it new-release movie is also a submarket in itself. Redbox should be noted that the claim that the studios should contends that “[b]ecause of the inelastic demand for each be prevented from price discriminating is an odd particular new-release DVD, Warner possesses significant claim for Redbox to make, since its own profitability market power for a particular new-release DVD and, in depends on the studios’ distribution window system the alternative, within a specific category or genre during that, according to Redbox, “prop[s] up an artificially the weeks immediately following the street date.

13 Redbox Automated Retail LLC v. Universal City Studios LLLP, Civil No. 08-766, 2009 WL 2588748, at *4 (D. Del. Aug. 17, 2009). The court’s summary equally describes Redbox’s complaint against Warner. 14 Amended Complaint, supra note 6, ¶ 50. 15 Id . ¶ 3. 16 “Premium” (i.e., early-release) video-on-demand may be facilitated by the Selectable Output Control technology recently approved by the FCC. Not surprisingly, the National Association of Theatre Owners (NATO) is quite concerned that premium video-on-demand may compete directly in the same window as the new theatrical releases. NATO, indeed, argues that the experience of the studios with DVDs has shown that they are “unable to resist the inexorable downward price pressure and commoditization of its products in later windows.” NATO interprets the studios’ “battle to carve out a DVD sell-through window against the $1-a-night kiosk rental services” as demonstrating the studios’ recognition of the harm done by firms such as Redbox. See National Ass’n of Theatre Owners, NATO’s Position on the Premium Window ,” June 14 2010, at 2, available at http://www.natoonline.org/pdfs/NATO%20VOD%20Statement%20June%202010.pdf.

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Consumers have few, if any, acceptable substitutes for a apparent that movie studios compete with each other to particular new-release DVD in a particular category or release movies that will attract large shares of consumer genre during the relevant time period .” 17 entertainment expenditures, and that each studio will attempt to time its release schedule optimally in order The “inelastic demand” and the alleged market power to minimize potential overlap with the releases of rival that Redbox claims to observe are artificial consequences studios, particularly those falling into the same genre. limiting the analysis to one particular release window established by the studios and ignoring the overall As a general matter, “[p]rice discrimination is common competition among studios. That is, there is a “new- in industries that though competitive do not sell a totally release DVD” market only because the studios delay the uniform, fungible product—and is pervasive in markets release of DVDs until after theatrical release, and because for intellectual property, even though those markets are the studios give the new-release market a head start over usually competitive—yet has no known adverse effects lower priced firms in later windows, including cable on efficiency sufficient to warrant the expense and 18 systems and broadcast television suppliers, as part of uncertainty of antitrust liability.” This proposition was their strategy to compete with each other. adopted by the Supreme Court in its Independent Ink decision, 19 in which the Supreme Court concluded that Consider the analogous definition as applied to airline a (patent) property right to a particular product transportation. Suppose that I have been notified at 8 a.m. combined with price discrimination did not provide a of a last-minute, in-person, business meeting scheduled presumption of market power. 20 for 2 p.m. in the afternoon and that I am located at two Redbox claims that the studios’ division of the market, hours’ flying distance from the location of the meeting. in which they attempted to force Redbox to buy only My demand for a 10 a.m. flight would be relatively from the studios as opposed to obtaining DVDs from inelastic, much more so than the demand for a new release wholesalers or retailers, was anticompetitive. These are DVD on a particular date. I have to hope that an airline non-price vertical restraints, but they differ from the has scheduled a flight in the time window that will permit vertical restraints that in other contexts are designed me to make my meeting. I can expect that unless my route to induce reseller behavior that fosters interbrand is heavily traveled, airlines will spread out their departures, competition. Is the situation different with the restraint each hoping to serve a distinct window. But if I find a in question that may potentially exclude a seller in order flight that works for my schedule requirements, does to facilitate price discrimination? It seems unlikely. By the airline offering the flight possess a monopoly over the same token, the tying at issue in Independent Ink a market defined as the flight offered in my window ? could have been a form of tying compatible with It is fair to say that airlines compete fiercely over routes competition, 21 and the price discrimination it facilitated and times, and that price discrimination in fares is was not necessarily a problem since price discrimination consistent with that competition. But it is similarly can “occur[ ] in fully competitive markets.” 22

17 Amended Complaint, supra note 6, ¶ 28. 18 WILLIAM M. LANDES & RICHARD A. POSNER, THE ECONOMIC STRUCTURE OF INTELLECTUAL PROPERTY LAW 375 (2003 ). 19 Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006). 20 Id . at 45-46. 21 See id . at 45 (“Many tying arrange¬ments, even those involving patents and requirements ties, are fully consistent with a free, competitive market.”) . 22 Id .

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While Redbox withstood a motion to dismiss by With delayed DVD release anticipated by consumers, pleading no more than the bare bones allegations the studios might also raise prices to theaters, resulting summarized above, were the issue to be revisited, one in rising ticket prices. Consumers who would have would expect more to be required to survive a challenge. preferred to buy DVDs earlier would be harmed as First, of course, Redbox would need to establish a market well. The studios might also move up the release dates to characterized by substantial market power. A product television outlets, but again, the benefit from the quicker market consisting of movies would not suffice. But even releases would be captured by the studios in increased if Redbox managed to obtain approval for a narrower charges to program distributors. It is certainly not submarket consisting of a particular release window obvious that consumers would benefit generally from (e.g., new-release DVDs), it would still need to allege a the window reshuffling. plausible anticompetitive effect of the challenged vertical The point of this discussion is that while it is not entirely restraints. The first challenge would be to convince a clear that consumers benefit from contractual vertical court that the price discrimination here was inconsistent restraints that extend the ability to price discriminate with the competitive price discrimination that the beyond that afforded by copyright law, it is equally Supreme Court has acknowledged as a possibility. Harm unclear that any competitive harm has taken place. But to Redbox will not suffice, of course, since vertical without much more, Redbox’s attempts to improve its restraints always restrain some downstream distributors window position do not appear to provide a basis for from undertaking actions that they would prefer. deploying the machinery of antitrust in this dispute. In order to demonstrate a harm to consumers generally, Redbox would be challenged by the ephemeral nature Class action against Netflix and Wal-Mart of its market definition. Suppose that the market were Wal-Mart has long been the largest retailer of DVDs. taken to be a particular window. Since that window In late 2002, Wal-Mart decided to enter the online is subject to adjustment by unilateral studio action, subscription rental business, joining Blockbuster in one would need to consider how the studios may offering a service that mimicked the Netflix rental model. alternatively respond to a sharp diminution to their But in 2005, having run into difficulty in attracting revenue stream obtained from the release window subscribers, Wal-Mart left the business, turning its Redbox wished to remain. If we assume that Redbox customers over to Netflix. Wal-Mart’s exit included an managed to drive down substantially the revenues that agreement that Netflix would promote DVD sales through studios obtained from the “new-release DVD” window, Wal-Mart and that Wal-Mart would, in turn, promote we would expect the studios to respond by narrowing Netflix’s service. A consumer class-action complaint alleged the window. They could do so by extending the length that the resulting agreement was market division, with of the theatrical release window. Since the current each seller agreeing to stay out of the other’s market. 23 window is set optimally by comparing the lost revenues from shortening the theatrical release window against This note is not the place to attempt to determine the gain from moving the DVD release closer to the buzz whether the deal between Netflix and Wal-Mart was a surrounding the new release, lowering the return to the horizontal agreement not to compete, or whether it simply DVD release would point to increased release delays. represented Wal-Mart’s effort to exit a failed business as

23 Consolidated Second Amended Class Action Complaint, In re Online DVD Rental Antitrust Litigation, MDL No. 2029 (N.D. Cal. Mar. 30, 2010), ECF No. 140.

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gracefully as possible. 24 A horizontal agreement not to window occupied by DVD sales (from retailers including compete is a much greater matter of concern than the Wal-Mart) and by higher-priced rentals. Why did studios extension of a price discrimination mechanism through impose the delay? A headline to a Business Week story the use of vertical restraints. This is because studios that on the subject reads: “Time Warner Says Netflix, Redbox create release windows to facilitate price discrimination Rental Delay Boosts DVD Sales.” It is apparent not only will have a very strong incentive to contract in such a that the studios believed that Netflix and Redbox substitute way that each segment they define is served competitively. for DVD sales, video-on-demand, and higher-priced Excessive margins due to the absence of competition will rentals, but also that their belief had empirical merit. be costly to the studios, reducing their share of consumer Note, finally, that even when the studios assigned Netflix revenues generated by the segment in question. Horizontal to a later window than new-release DVDs, Netflix still had agreements do not have a participant with a similar desire company in that window. Redbox, Blockbuster Express, and to promote low margins . Netflix were positioned to compete with each other for While no studio was a direct participant in the delayed low-price DVD rentals. But to the extent that these Netflix/Wal-Mart deal, the studios were necessarily firms occupy the same segment, the argument that Wal-Mart involved in designing the business for DVD rentals, and (which had a low subscription numbers) ceded the segment their actions tell us something about the market definitions to Netflix is compromised: check a neighborhood Wal-Mart, appropriate for the online DVD rental antitrust dispute . and you will likely find a Redbox kiosk located there.

The amended class action complaint proposes a very Conclusion simple and narrow market definition, the “Online DVD The market for movies is sliced into many small Rental Market.” This market is narrower than the title segments in order to facilitate price discrimination. would suggest: it includes only subscription service The presence of that discrimination should not, however, rentals of the type offered by Netflix, Wal-Mart, and lead one to conclude that the marketplace is less than Blockbuster. The plaintiffs argue that “there have been competitive. Boundaries between market segments no reasonably interchangeable substitutes for the service fluctuate as prices are fine-tuned, but the interest of the of online DVD rentals, which is differentiated, from studios in promoting competition within each segment both the demand and the supply side, from other is likely to be a better protection against anticompetitive methods of DVD distribution channels, as well as behavior than is the deployment of antitrust law. But other methods of entertainment content delivery.” with both Redbox and the Netflix/Wal-Mart plaintiffs The studios’ actions suggest an alternative position. Low- having achieved at least some success in pursuing their price delivery systems including Netflix, Redbox, and claims, and with the boundaries of market segments Blockbuster Express have each been shifted to a window continuing to shift, it is likely that antitrust will continue with a delay in comparison to the new-release DVD to be invoked in entertainment markets in the future.

24 At the time Wal-Mart exited the online DVD rental business on May 19, 2005, it is estimated to have had 100,000 subscribers compared to the 3 million subscribers that Netflix had at the time. See Robert D. Hof, Netflix 1, Wal-Mart 0 , BLOOMBERG BUSINESSWEEK, May 20, 2005, available at http://www.businessweek.com/technology/content/may2005/tc20050520_3983_tc024.htm. 25 Consolidated Second Amended Class Action Complaint, supra note 22, ¶ 30 26 Id. ¶ 34. 27 Sarah Rabil, Time Warner Says Netflix, Redbox Rental Delay Boosts DVD Sales , BLOOMBERG BUSINESSWEEK, Aug. 4, 2010, available at http://www.businessweek.com/news/2010-08-04/time-warner-says-netflix-redbox-rental-delay-boosts--sales.html.

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