Court Opinion

ID: 3187529
Source: CourtListenerOpinion
Date Created: 2016-03-22 15:04:20.044669+00
Date Added: 2024-06-11T12:18:54.672222
License: Public Domain

United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 20, 2015               Decided March 22, 2016

                         No. 15-1018

              UNITED STATES POSTAL SERVICE,
                       PETITIONER

                              v.

             POSTAL REGULATORY COMMISSION,
                      RESPONDENT

             GAMEFLY, INC. AND NETFLIX, INC.,
                     INTERVENORS

             On Petition for Review of an Order
            of the Postal Regulatory Commission

    David C. Belt, Attorney, U.S. Postal Service, argued the
cause and filed the briefs for petitioner. Stephan J. Boardman,
Chief Counsel, entered an appearance.

     Henry C. Whitaker, Attorney, U.S. Department of Justice,
argued the cause for respondent. With him on the brief were
Benjamin C. Mizer, Principal Deputy Assistant Attorney
General, Michael S. Raab, Attorney, David A. Trissell, General
Counsel, Postal Regulatory Commission, Christopher J. Laver
and Anne J. Siarnacki, Deputy General Counsels, and Richard
A. Oliver, Attorney.
                                 2

    Joy M. Leong, David M. Levy, and John F. Cooney were on
the brief for intervenors GameFly, Inc. and Netflix, Inc. in
support of respondent. Matthew D. Field entered an appearance.

    Before: PILLARD, Circuit Judge, SILBERMAN and SENTELLE,
Senior Circuit Judges.

    Opinion for the Court filed by Senior Circuit Judge
SILBERMAN.

     SILBERMAN, Senior Circuit Judge: The Postal Service offers
a host of different products for consumers and businesses. By
statute, the Postal Service’s products are divided into
“competitive” products, which are subject to a statutory price
floor, and “market-dominant” products, which are subject to a
statutory price ceiling. In this case, the Postal Service applied to
the Postal Regulatory Commission to have one of the Service’s
products, the “round-trip mailer,” used in the DVD-by-mail
industry, classified as competitive rather than market-dominant.
The Commission denied the request, and the Postal Service
petitioned for review. We deny the petition.

                                 I.

    The round-trip mailer is a product used by intervenors
Netflix and GameFly whereby customers receive a DVD disc by
mail that they can return with an enclosed envelope. Netflix, a
provider of movies, is the dominant purchaser of this product,
with nearly 97 percent of purchases.1 It is provided only by the
Postal Service; Fed Ex and UPS do not offer anything similar.
Customers, to be sure, can also rent DVDs at various physical
locations, such as storefronts and kiosks, but these alternatives
are declining. Movies can also be delivered to customers

    1
        GameFly provides video games on disc.
                                 3

through streaming directly to televisions or computers, and that
is a booming market in which Netflix, which also offers
streaming, meets a number of direct competitors.

     Netflix customers are, in huge numbers, leaving the DVD-
by-mail service. After peaking in 2010, DVD-by-mail declined
14 percent, and then another 41, 21, and 22 percent, year over
year. Meanwhile, streaming service continues to expand,
growing 26, 25, and 19 percent, year over year, from 2012 to
2014. Nevertheless, a significant core continues to use the
round-trip mailer service, in part because the content available
through the round-trip mailer is more extensive than that
available through streaming and, in part, for difficulties in
reception with streaming. Indeed, nearly two-thirds of all DVD-
by-mail customers also subscribe to streaming. Importantly,
although the round-trip mailer is a declining product, it remains
quite profitable to Netflix, with a profit margin of nearly 50
percent. That makes it considerably more profitable than
streaming.

     In 2013, the Postal Service formally requested that the
Commission remove the round-trip mailer from the market-
dominant list, where it is subject to a statutory price ceiling, and
place it on the competitive product list, where it would be
subject to only a statutory price floor. The request was opposed
by intervenors Netflix and GameFly, as well as by a
Commission-appointed public representative. Market-dominant
products obviously include those that are an actual monopoly,
but the governing statute describes market-dominant products
more broadly as those “in the sale of which the Postal Service
exercises sufficient market power.” See 39 U.S.C. §3621-3634.

     As noted, the Commission denied the request. Applying
antitrust concepts, it defined the relevant market as the physical
delivery of DVDs by mail, and ruled that the Postal Service, as
                                    4

the only entity producing the round-trip mailer, exercised
sufficient power within that market to justify a market-dominant
classification.

                                   II.

    Section 39 U.S.C. § 3642(b)(1), the governing statute’s
definition of a market-dominant product, includes all products
meeting the following description:

          [E]ach 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 significant levels of
          business to other firms offering similar products.
          (emphasis added)

     It would seem that a permissible reading of the statute
would foreclose the Postal Service’s position because arguably
there really are no products in the marketplace “similar” to the
round-trip mailer. But the Commission does not rely on that
interpretation of the language. Instead, the Commission and all
parties agree that the statute should be read as incorporating
general concepts of federal antitrust law.2

   In that regard, the Postal Service contends that the
Commission erred in its definition of the market. First, it made

     2
      A statutory price cap, indexed to inflation, is meant to assure that
the Postal Service does not abuse a dominant position, see U.S. Postal
Serv. v. Postal Regulatory Comm’n, 785 F.3d 740, 744 (D.C. Cir.
2015). This is not unlike rate regulation for other state-granted
monopolies. The language of 39 U.S.C. § 3642 has been consistently
taken to reflect basic antitrust concerns with market power.
                               5

too much of the difference between DVD-by-mail and streaming
services, whereas antitrust law has traditionally recognized that
even differentiated products, provided they are reasonable
substitutes for one another, may be included in the same market.
In this case, the precipitous drop in DVD-by-mail customers,
which has attended the concurrent rise in streaming services,
strongly suggests, argues the Postal Service, that a substantial
substitution is taking place, at the consumer level, between the
two forms of delivery. That substitution is an indication that
whatever the differences between DVD-by-mail and streaming,
customers see them as similar enough that they ought be
considered in the same market. And as DVD-by-mail service is
in the same market as streaming services downstream, the
Service argues that streaming services have the effect of
disciplining the price the Postal Service can charge for DVD-by-
mail service upstream, thus mitigating any market power.

     Secondly, the Postal Service argues that the Commission
relied too heavily on the “core” group of DVD-by-mail
consumers who do not use streaming services. While any
product will have core consumers who refuse to switch products
even in the face of price increases, the Commission, we are told,
overemphasized their numbers or loyalty. This misconception
led to an unduly narrow definition of the downstream market,
failing to take account of the constraints faced by the Postal
Service upstream in setting its price for the round-trip mailer.

     In the alternative, the Postal Service offers two arguments
apart from market definition. Even if the definition of the
relevant market was not unreasonable, the Commission still
failed to consider that Netflix, as a near-monopsonist in
purchasing the round-trip mailer upstream, can exercise strong
countervailing buyer power. As such, it would limit the Postal
Service’s pricing discretion. And the Commission did not
consider that the market, defined as either DVD-by-mail or
                                6

distribution of content generally, is in a constant state of
technological evolution. Such change provides an intrinsic
limitation on the exercise of market power.

     The Commission’s arguments dovetail with its
considerations set forth in its order. In defending its definition
of the relevant market as limited to DVD-by-mail, the
Commission emphasizes evidence that DVD-by-mail provides
a different range of material, and services a different base of
consumers, than streaming and other distribution channels.
Regarding substitutability, it is noteworthy that many customers
subscribe to both DVD-by-mail and streaming services. It
further disputes the Postal Service’s assertion that the
simultaneous decline in DVD-by-mail subscriptions and
increase in streaming subscriptions suggests a high enough
substitutability to justify a unified market, because the shift
toward streaming may have nothing to do with price sensitivity
of DVD-by-mail customers; it may just as well result from
broader market trends unrelated to price-based substitution.

     The Commission stresses that the Postal Service bore the
burden in the present case. It was obliged to present evidence
demonstrating that, despite the fact that the Postal Service is the
only entity providing the round-trip mailer for DVD-by-mail
services, it nevertheless lacked market power. That evidence,
particularly in the form of price elasticity data, was lacking.
Thus, the Commission argues it was reasonable to conclude that
the Postal Service did not meet its burden.

    Finally, the Commission contends that even if there is
downstream competition between delivery by mail and delivery
by other means (such as streaming and kiosks), the Postal
Service still failed to show that it would not be in a position to
simply capture more of Neflix and GameFly’s profits upstream.
Even if increased prices resulting from a new classification
                                 7

could not be passed on by Netflix and GameFly because of
rugged downstream competition, the removal of a price ceiling
would allow the Postal Service to use its position as the sole
provider of the round-trip mailer to capture a larger portion of
the intervenors’ profits.

                              * * *

     Petitioner’s case essentially rests on the proposition that the
proliferation of competitors in the downstream market (direct
sales to consumers) restricts the capacity of the Postal Service
to raise prices to Netflix and GameFly. Therefore, the Postal
Service contends, streaming services and DVD-by-mail services
compete with each other and, under antitrust law, should be
treated as a single market. We should note at the outset of our
analysis that we do not sit as an appellate court reviewing an
antitrust case from the district court. Rather we are reviewing
an administrative agency decision under the APA – which
means the agency is entitled to deference. Even if we were to
disagree with the Commission’s economic analysis, we are
obliged to affirm if the agency was at least reasonable.3 See City
of Los Angeles v. Dept. of Transp., 165 F.3d 972, 977 (D.C. Cir.
1999) (“[W]e do not sit as a panel of referees on a professional
economics journal, but as a panel of generalist judges obliged to
defer to a reasonable judgment by an agency acting pursuant to
congressionally delegated authority.”).

    But we think the Commission was more than just
reasonable; its decision seems rather compelling. As the
Commission found, the petitioner produced no evidence to

    3
     In other words, not arbitrary and capricious, see Gundersen
Lutheran Med. Ctr., Inc. v. Sebelius, 666 F.3d 1335, 1337 (D.C. Cir.
2011); Blumenthal v. FERC, 613 F.3d 1142, 1146-47 (D.C. Cir.
2010).
                                  8

establish that a significant increase in the price of DVD-by-mail
– the cost to Netflix and GameFly in the upstream market –
would result in a significant shift by Netflix or GameFly away
from purchasing DVD-by-mail services upstream. In other
words, there was no evidence presented to establish at what
point an increase in the price the Service charged would cause
Netflix and Gamefly to look elsewhere for distribution.

      There is a fundamental logical flaw in the Service’s
argument. The Service enjoys market power in the (upstream)
distribution market regardless of conditions in the (downstream)
content market because it does not face any competition in the
distribution market. Whether because of economic or legal
hurdles, no other business offers or seems reasonably poised to
offer a competing distribution channel that Netflix could readily
take advantage of. If the Postal Service were to raise the price of
its round trip mailer to Netflix and GameFly, there are only two
possibilities. First, it may be the downstream market is not
sufficiently competitive, and thus Netflix and GameFly could
pass on the price increase to consumers without consequence.
Second, alternatively, it may be the downstream market is
competitive, and thus Netflix and GameFly could not pass on
the price increase to consumers without losing them. In the first
instance, the Postal Service’s market power upstream coexists
with Netflix and Gamefly’s market power downstream. They
would share in the supracompetitive price. In the second
instance, although Netflix and Gamefly lack power downstream,
the Service’s power upstream remains, and puts it in a position
to extract more of the profit margin of its captive suppliers. In
either case, the Postal Service employs market power.4

     4
     Court precedent, and antitrust doctrine generally, recognize that
market power may be exercised upstream, even where there is a
competitive market downstream. See Coal Exporters Association v.
United States, 745 F.2d 76, 84-85 (D.C. Cir. 1984); 2B AREEDA ET.
                                 9

     There remain petitioner’s two other arguments, even
assuming it can be thought to have market power. First, that
Netflix – after all, a market behemoth – has sufficient economic
clout to counter petitioner’s market power. But that theory
simply doesn’t apply in this case because Netflix and GameFly
have no alternative means to transport DVDs by mail, so there
is no way that Netflix could exercise any bargaining leverage
vis-a-vis the Postal Service. It should be obvious that as long as
the DVD-by-mail business is quite profitable, Netflix has no
rational economic course but to pay the market-dominant piper.
As to the second alternative argument, regarding the speed of
technological change, we have said that market power analysis
need account for only potential “substitutes that constrain
pricing in the reasonably foreseeable future.” United States v.
Microsoft Corp., 253 F.3d 34, 53-54 (D.C. Cir. 2001). The
Commission was not, therefore, unreasonable to hold that the
potential technological evolution suggested by the Service was
too speculative to condition its market power analysis here.

    For the foregoing reasons, we deny the petition for review.

                                                        So ordered.

AL., ANTITRUST LAW    ¶ 564 (4th ed. 2014). This effect is recognized
in several other antitrust inquiries that involve market power, see
Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co., Inc., 549
U.S. 312 (2007) (finding buyer power in upstream market for inputs,
despite lack of seller power in national downstream market for
outputs); Mandeville Island Farms v. American Crystal Sugar Co.,
334 U.S. 219 (1948) (finding market power upstream, despite lack of
power downstream); EINER ELHAUGE, UNITED STATES ANTITRUST
LAW AND ECONOMICS, 172, 263 (2d ed. 2011); HERBERT
HOVENKAMP, FEDERAL ANTITRUST POLICY, § 8.10 (4th ed. 2011).