Apple’s Refusal to License its Apple’s Refusal to License its DRMs – DRMs – FairPlayFairPlay Competition? Competition?

20 October 200720 October 2007

Nicolas PetitNicolas Petit

The contextThe context

The “buzz” around Apple’s music business:

• Consumer protection agencies in Norway declaring Apple’s MusicStore “illegal” (January 2007);

• Procedure pending before DG COMP re. Apple’s pricing policy in different Member States: downloading a song costs 0.99 € in Germany and France, while it costs 0.79£ (1.16€) in the UK.

The CaseThe Case

The Apple/Virgin-Mega decision, Conseil de la concurrence, 9 November 2004:

• Virgin Mega, a French online music provider, alleges that Apple is using its Digital Rights Management (“DRMs”) technology to foreclose competition, thereby abusing its dominant position in online music markets;

I.I. The FactsThe Facts

Apple’s iTunes MusicStoreApple’s iTunes MusicStore

A website where consumers purchase digital content online:

Apple’s iPod Music PlayerApple’s iPod Music Player

A portable music player with a hard drive that plays digital content downloaded online:

Apple’s RivalsApple’s Rivals Upstream level – MusicStore competes

with other online platforms:

Downstream level – iPod competes with other digital music players:

The Interoperability ProblemThe Interoperability Problem

Music downloaded on Virgin-Mega.fr cannot be played – directly – on iPod

Music downloaded from iTunes cannot be played – directly – on other music players

The Source of the Interoperability The Source of the Interoperability Problem – Apple’s DRMProblem – Apple’s DRM

Online music stores encrypt music titles with DRMs, to restrict use of a song/title, once downloaded by a customer;

To play a downloaded title, the music player must be compatible with (or “read”) the DRM;

Apple, as a vertically integrated firm, follows a well-known “closed” business model. It has developed its own DRM internally, FairPlay. Its downstream product, iPod, only reads “FairPlayed” files. Apple does not license the FairPlay technology to other online music shops.

The “DRM” Technology – Some The “DRM” Technology – Some PrecisionsPrecisions

What is a DRM? A system of technical measures which restricts the possible use of a song/title, once downloaded by a music customer;

Music publishers require online music providers, such as Apple, to apply DRMs on files available for sale in their catalogues;

Most online music providers protect music data with DRMs;

Online music providers may either have their own DRM technology (e.g. Apple), or purchase it from a technology seller (e.g. Microsoft);

IP rights cover proprietary DRM technology: Apple FairPlay

Sony’s Open MG

RealNetworks Helix DRM

Microsoft WMDRM

The DisputeThe Dispute

In 2004, Virgin-Mega asks Apple for a licence on its FairPlay DRM technology;

Apple refuses to licence the FairPlay technology to Virgin-Mega;

Apple’s FairPlay is not made available for licence to other online platforms;

Since Virgin-Mega cannot “Fairplay” its music content, it cannot sell music to iPod’s owners.

FairPlay DRM

MSFT DRM Other DRM

Other DRM

Sale of music titles to online

distributors

Sale of DRMed music titles to end

users

II.II. The CaseThe Case

The ComplaintThe Complaint

Virgin-Mega brings a complaint before the Conseil de la Concurrence in 2004;

Apple is abusing a dominant position by refusing to grant access to its FairPlay technology, thereby distorting competition in the market for the downloading of online music;

Apple infringes both Article L-420-2 of the code of Commerce and Article 82 EC.

Virgin-Mega’s AllegationsVirgin-Mega’s Allegations

Apple is dominant in the market for portable music players with a hard-drive and in the market for the sale of online music;

Access to Apple’s FairPlay is indispensable to access iPod users and thus to be a viable provider of online music;

FairPlay is an essential facility;

Apple’s refusal to license FairPlay, is akin to an abuse of a dominant position in the neighboring market for portable music players with a hard-drive;

DominanceDominance

Virgin-Mega:

• Apple holds 25% of all MP3 players, and 53% of players with hard drive;

• Apple is also dominant on the market for the downloading of online-music;

Conseil de la concurrence:

• On both markets, the question of dominance can be left open;

• Yet, a number of elements run contrary to finding of dominance: dynamic market with growth, entry of new competitors, downwards pressure on prices, huge investments, increase in product functionalities, etc.

AbuseAbuse

Virgin-Mega: Apple’s refusal to license its proprietary FairPlay technology is akin to an abusive refusal to grant access to an essential facility;

It harms (i) competitors on the online music market, and is detrimental to the (ii) consumer who must purchase necessarily from Apple’s iTunes MusicStore.

Four Cumulative Conditions Four Cumulative Conditions underunder EC EC Case-Law (Case-Law (Commercial SolventsCommercial Solvents; ;

Magill; IMS HealthMagill; IMS Health))1. The refusal relates to a product or

service indispensable to access the market;

2. The refusal risks eliminating competition;

3. The refusal prevents the appearance of new products;

4. Absence of objective justification.

Condition 1 – IndispensabilityCondition 1 – Indispensability

The Conseil de la concurrence interprets “indispensability” to mean that “there are no existing or potential substitutes”;

In the present case, FairPlay is not “indispensable” to operate on the online music market:

• Online music is not only listened on digital music players: Most users listen music on their PCs. Virgin-Mega can sell to many other users than iPod users;

• iPod users can download music from Virgin-Mega, and then transfer it to their iPod by burning a CD;

• Many digital music players are appearing in France. The size of the market addressable by Virgin is therefore expanding.

Condition 2 – Elimination of Condition 2 – Elimination of CompetitionCompetition

The Conseil de la concurrence interprets “elimination of competition” as “a complete elimination” of competition;

In the present case, there is no risks of complete eliminating of competition. The market for online downloading is “buoyant”:

6 operators;

2 new entrants;

Numerous potential competitors;

High pressure on profit margins.

The French Touch – A 5th Condition?The French Touch – A 5th Condition?

The Conseil de la concurrence adds a condition generally not examined under EC law: the existence of a causal link between the allegedly abusive behaviour and the competitive conditions observed in the market;

In other words, the Conseil de la concurrence applies the well-known, but still virtual, “effects-based” approach promoted by the EC Commission

In the present case, there is no “causal link” between Apple’s alleged abuse and Virgin’s poor performance:

• Virgin’s lack of success may be explained by:

• limited catalogue (350,000 v 700,000 tracks);

• prices (€1,19 v €0,99);

• marketing expenditures;

• more liberal content usage rules.

• Apple’s performance may be explained by commercial superiority.

III.III. ConclusionsConclusions

Alternative Ways to Solve Alternative Ways to Solve Interoperability IssuesInteroperability Issues

Is this really an issue to be dealt with under competition law?

• Alternative allegations? Possibility to argue that Apple’s practices amounted to illegal technical bundling (or full line forcing), pursuant to Article 82 d) EC?

An issue to be dealt with under copyright laws? The French approach (DADVSI Law, 1 August 2006)

• Article L. 331-5 provides that TPMs “must not have the effect of preventing effective interoperability”;

• Suppliers of TPMs can be required to give access to “the information essential for interoperability”

An issue to be dealt with under consumer protection laws? the Norwegian approach

• “DRM must be considered part of the contract terms (with consumers) and not a copy protection scheme only”

Who’s the Bad Guy Anyway?Who’s the Bad Guy Anyway?

S. Jobs, Apple, CEO P. Nègre, Universal

Music France, CEO

The Big Four alledgedly prevent the The Big Four alledgedly prevent the rise of DRM-free musicrise of DRM-free music

Steve Jobs, Apple's chief executive, has published an article on DRM on the Apple website:

• Licensing FairPlay would create serious risks that the DRM would be breached, because a DRM system employs secrets.

• Highlighting the fact that the big four music companies are in large part controlled from Europe, where most of the pressure for FairPlay licensing has come, he encourages those who argue for inter-operability to convince them to license their music for online distribution without DRM, which Apple would "embrace wholeheartedly".

• "If the big four music companies would license Apple their music without the requirement that it be protected with a DRM, we would switch to selling only DRM-free music on our iTunes store.”