Archive for category: Insights

The upward trajectory in equity markets has continued unabated. Markets continue to be supported by low interest rates and central bank liquidity support. The US Federal Reserve’s recent comments that that they would continue their asset purchase program and that interest rates are not expected to rise anytime soon has added fuel to markets. This is despite growing concerns of rising inflation, which has been a major focal point for central banks and investors alike. One of our observations is that markets are disregarding any negative news which is of concern as this is typical behavior in the late stages of a bull market. Uncertainty also remains as to the playbook the pandemic will follow. The spike in the Delta strain of Covid-19 has highlighted the evolving nature of the virus and, as we have seen domestically, it has had a material impact on Australia’s ability to ‘open up’, which has had a detrimental impact on many households and small businesses. Furthermore, geopolitical risk continues to flare up with the recent retreat of the US from Afghanistan creating a power vacuum in that region.

Our asset allocation positioning has been positive for investors as we have maintained an overweight exposure to risk assets such as equities. We are seeing that asset valuations in some sectors are looking stretched as the market has extended its rally. We are looking at ways to further diversify our portfolios as well as looking at opportunities to take profits via portfolio rebalancing where appropriate. The main challenge from a portfolio construction perspective at the moment is that bonds and cash do not look particularly attractive, so the hunt for other diversifying assets is a focus for us. Within our multi-asset portfolios, we have incorporated a range of assets such as gold and alternative strategies to provide diversification from equities and bonds.

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With the growing dominance and potentially anticompetitive nature and conduct of big tech multinational players of the likes of Amazon, Facebook, Apple and Alphabet, there is bipartisan support behind the need for antitrust reform. US President Joe Biden’s appointment of staunch antitrust reform advocate Lina Khan as Chair of the Federal Trade Commission in June this year, reinforces the Biden administration’s firm intent to seek to address the broad range of antitrust concerns. In her role as Chair, Lina Khan will work with Congress on bills to limit the power of big tech companies, collaborate with European regulators on antitrust issues, and will be involved in deciding whether to launch antitrust investigations and court cases.¹ Amazon is currently being investigated by the FTC for past acquisitions, treatment of third party sellers and its cloud services business. As evidenced by recent flurry of capital outflows in response to significant regulatory change targeting the technology and education sectors in China, regulatory and ESG risks can have a material impact on stock markets. This article discusses the rationale behind the need for antitrust reform which has been articulated by Khan and other advocates in the area, using the example of Amazon, to capture the reality of the anticompetitive risks that big tech companies present to society.

Amazon has an undeniably impressive long-term track record as a growth company. It has a substantial and growing addressable market, with promising businesses in AWS and Alexa, as well as value-add opportunities in Amazon Prime, grocery delivery and healthcare. As a result, it is often a ubiquitous and prominent holding in the portfolios of growth investment managers, which has proven to be a multi-bagger stock, and then some. AWS is a “scale as a service” platform, which delivers IT infrastructure services online. It has been transformational in making cloud computing more accessible and affordable to smaller companies, and its scale has enabled Amazon to invest more in the development and management of services than what would have otherwise been possible.² Following Congressional hearings last year, the US House of Representatives’ Antitrust Subcommittee established that Amazon has “significant and durable market power in the US online retail market”, with monopoly power over third party sellers on its platform and suppliers.³ Amazon have developed a valuable service for vendors and consumers, built a strong market position and are entitled to a return on their substantial investment and innovation over the years. They have acted on a strategy of heavy reinvestment and research and development to produce a more competitive offering for consumers. However, there is growing recognition of the need for sufficient checks and balances to ensure that anticompetitive hazards are mitigated.

Theoretical Underpinnings of Antitrust Law

There has been a shift in approaching antitrust from economic structuralism toward consumer welfare. The current approach was introduced by Judge Robert Bork and supported by the University of Chicago Law school through the Chicago School of Antitrust framework. This approach narrows the scope and application of the law to focus solely on consumer welfare, specifically consumer prices, rather than the entire spectrum of market participants and implications to market power dynamics in the economy. Antitrust laws are centred on the objective of maximising consumer welfare, measured primarily through prices. Furthermore, the view is that consumer welfare is best achieved through market efficiency, in which firm size, structure and concentration are a result of market forces.⁴ Consistent with this theory, Amazon as a profit maximising actor, has a large market share and integrated supply chains. Its concentrated structure enables it to achieve lower prices and thereby maximise consumer welfare. This approach overlooks risks Amazon poses to competition and other market participants, and the multitude of other ways it can exploit market power. Market efficiency lies on the premise that rational economic actors will maximise profits by combining inputs in the most efficient manner. However, economic actors do not always act rationally and unchecked and without proper oversight have opportunities to act unfairly for the ultimate detriment of consumers. Monopolies and oligopolies increase barriers to entry, risks of collusion and price fixing, and lowers the pricing power of consumers, suppliers and even employees.⁵ Amazon has barriers to entry that assist the durability of its market power, including high switching costs for consumers to shop outside Amazon’s ecosystem and its fulfilment and delivery advantage through a large logistics network.⁶ In addition, network effects and data collection that cannot be easily replicated by new entrants, further increase these barriers.⁷ As Congresswoman Pramila Jayapal stated when questioning Jeff Bezos in the antitrust Congressional hearings in 2020, Amazon can monitor third party vendors on their platform so there is a risk competitors don’t get big enough so that they can never essentially compete.

Antitrust ideology in the 1960s centred on the theory of concentrated economic structuralism, which takes the view that concentrated market structures promote anticompetitive conduct. Markets with several small and medium sized companies are more competitive in structure than where it is concentrated among a few large players. Thus, the application of antitrust law was broader and took into consideration the interests of these stakeholders, including suppliers, employees, and competitors. Even if current interpretation of antitrust is correct in its focus solely on consumer welfare, consumer prices are only one measure of consumer welfare. This approach ignores the totality of consumer welfare including product quality, variety and innovation.⁸ These are best fostered through open markets and competition, rather than concentrated market structures with a few, large powerful companies.⁹ The aim of antitrust law should be to promote market competition and ensuring market power is appropriately distributed to achieve this, rather than consumer welfare.¹⁰ Practically, however, it is difficult to envisage that the application of this approach should result in the break-up of big tech companies. In the case of Amazon, the economies of scale arguments hold true, the vertical integration of business provide cost advantages to consumers that could not otherwise be achieved. However, closer regulatory oversight of big tech companies to prevent infringement upon interests of other stakeholders may be warranted.

There is broad support for the view that the Supreme Court’s interpretation of legislative intent behind the Sherman Act as a consumer welfare prescription is inaccurate. The genesis of antitrust was based on several aims, including to control and distribute the power of large industrial trusts and ensure that they did not impinge upon the opportunities for newer entrants in the market.¹¹ In fact in the 1960s the Supreme Court specifically highlighted that the legislative intent of antitrust was to prevent concentrations of economic power,¹² which reduced economic competition and gave rise to the potential for significant political control.¹³ Congressional debates by Senator Sherman himself highlighted one of the purposes of Congress during the 1890s was to protect an industry structure of small units which effectively compete with each other.¹⁴ Whilst this was the legislative intent of the 19th and 20th centuries, intent of Congress is an important basis for courts in interpreting and applying legislation.

Predatory Pricing

Whilst companies are entitled to competitively price and discount goods and services, predatory pricing to eliminate competition is illegal. However, the distinction between the two can be difficult to determine. In 2009, Quidsi, a growing e-Commerce business declined Amazon’s acquisition offer. Amazon subsequently aggressively reduced prices on product categories sold by Quidsi including diapers and baby products. Amazon used its data advantage, with pricing bots monitoring and following any price cuts made by Quidsi. Amazon’s product manager admitted to a strategy to match prices no matter what the cost.¹⁵ Ultimately, this resulted in the sale of the business to Amazon, after which Amazon raised the prices on products that were previously discounted. Arguably Amazon used its market power to undermine competition. Advocates may argue that this is the type of conduct which the Clayton Act was designed to prevent, as articulated in Congressional debates ‘by the use of this organized force of wealth and money the small men engaged in competition with them are crushed out; and that is the great evil at which all this legislation ought to be aimed.’¹⁶ On the other hand, it may be argued that this is an example of competitive pricing. Companies often compete on prices to attract and gain customers. Amazon thus could at best be said to have engaged in a pricing war with Quidsi on similar products, which ultimately resulted in Quidsi’s sale. In a general sense mergers and acquisitions can aid platforms in achieving scale, gain functionality to provide to its large user base as well as obtaining talent and resources for innovation.¹⁷ However, even if we are to look at antitrust through the lens of the consumer welfare standard, Amazon’s conduct significantly reduced the degree of competition and choices in the market when in Amazon’s own view it believed that Quidsi was its largest short term competitor.¹⁸ This seems to meet the FTC’s guidance on predatory pricing in that it harmed consumers by allowing a ‘dominant competitor to knock its rivals out of the market and then raise prices to above-market levels for a substantial time.’¹⁹

Amazon’s significant size and influence enables losses from aggressive pricing strategies to be offset and recouped through other avenues, including charging publishers higher fees for services.²⁰ In an incident termed the “Gazelle Project”, small book publishers, dependant on Amazon for sales, were subjected to unfavourable treatment if they did not agree to more favourable terms during contract negotiations.²¹ Similar instances were highlighted by the US House of Representatives’ Antitrust Subcommittee, such as Amazon threatening retaliation if publishers would not accept contractual terms that limited their ability to work with Amazon’s rival e-book retailers.²² Publishers are at a structural disadvantage in negotiations not only because they rely on Amazon for distribution and marketing, but also because Amazon is vertically integrated into publishing and may promote its own content over external publishers.²³

Advocates argue that predatory pricing laws should be more strongly enforced to reflect the uncertainty surrounding predatory pricing. Predatory pricing cases are rarely brought in the US. The Clayton Act of 1914 prohibited large companies from reducing prices below the cost of production to eliminate competitors and make their business unprofitable, and with the aim of becoming a monopoly.²⁴ Similarly, the Robinson-Patman Act of 1936 aimed to prevent conglomerates and large companies from using their buying power to obtain discounts from smaller companies to destroy competition.²⁵ However, the Supreme Court has adopted the view that rather than predation, there is a greater risk of price competition being misclassified as predation (Matsushita Electric Industrial Co v. Zenith Radio Corp). This is because the success of predation schemes of predatorily low prices is uncertain in the long-term. The Chicago School’s critique of predatory pricing was that below cost pricing is irrational, unsustainable and rarely occurs.²⁶ Economics is not an exact science and the Chicago School’s argument is not an unbreakable principle of law.²⁷ The Chicago School undermined the idea that price discrimination could be used to create monopolies, which they argued was the premise of the Robinson-Patman Act. Indeed, Amazon uses below cost pricing as a systematic and highly effective strategy, and whilst prima facie irrational, below cost pricing can nonetheless prove to be sustainable in the long term and enabler of gaining market share. This is not necessarily conclusive that Amazon engages in predatory pricing but evidences the outdated thinking behind predatory pricing and the need for this to be revisited.

Amazon have developed a valuable service to consumers, third-party vendors and publishers on its eCommerce platform. As a result of significant and continuous reinvestment into the company it has earned its strong market position and are entitled to a return on investment. However, the dominant business structure and power imbalances of third-party vendors elevates risks of anticompetitive harm. Closer regulatory oversight may be needed to protect the interests of these broader groups of stakeholders albeit the market will be very wary of the impact such regulations may have on the earnings power of Amazon and other big tech companies.

Author: Asha Rahman, Associate Analyst
Approved by: James Kirk, Manager – Global Equities & Alternatives

1. The Economist, ‘Joe Biden appoints Lina Khan to head the Federal Trade Commission’, 19 June 2021 < https://www.economist.com/united-states/2021/06/19/joe-biden-appoints-lina-khan-to-head-the-federal-trade-commission>.
2. Baillie Gifford, Portfolio Construction Forum 2021.
3. Subcommittee on Antitrust, Commercial and Administrative Law of the Committee of the Judiciary, US House of Representatives, Investigation of Competition in Digital Markets, Majority Staff Report and Recommendations (2020) 254.
4. Lina M Khan, ‘Amazon’s Antitrust Paradox’ (2017) 126 Yale Law Journal 710, 720.
5. Ibid.
6. Subcommittee on Antitrust, Commercial and Administrative Law of the Committee of the Judiciary, US House of Representatives, above n 3, 260.
7. Khan, above n 4, 772.
8. Ibid 737.
9. Ibid 739.
10. Ibid 737.
11. Ibid 740.
12. Greenfield B Leon, Lange A Perry and Nicole Callan, ‘Antitrust Populism and the Consumer Welfare Standard: What are we Actually Debating?’ (2019) 83(2) Antitrust Law Journal, 2.
13. Darren Bush, ‘Consumer Welfare Theory as an Ethical Consideration: An Essay on Hipsters, Invisible Feet, and the “Science” of Economics’ (2018) 63 The Antitrust Bulletin 509, 511-12.
14. Ibid 513.
15. Sarah Oh, ‘Is there evidence of antitrust harm in the house of judiciary committee’s hot docs?’ (2021) 37 Santa Clara High Tech Law Journal 193, 199.
16. Sandeep Vaheesan, ‘The Profound Nonsense of Consumer Welfare Antitrust’ (2019) 64 The Antitrust Bulletin 479, 481.
17. D Daniel Sokol and Marshall Van Alstyne, ‘The Rising Risk of Platform Regulation’ (2020) 62(2) MIT Sloan Management Review, 3.
18. Ibid.
19. The Federal Trade Commission, ‘Predatory or Below-Cost Pricing’ <https://www.ftc.gov/tips-advice/competition-guidance/guide-antitrust-laws/single-firm-conduct/predatory-or-below-cost>.
20. Khan, above n 4, 765.
21. Business Insider Australia, ‘Sadistic Amazon Treated Book Sellers “The Way a Cheater would Pursue a Sickly Gazelle”’, 23 October 2013, <https://www.businessinsider.com.au/sadistic-amazon-treated-book-sellers-the-way-a-cheetah-would-pursue-a-sickly-gazelle-2013-10?r=US&IR=T>.
22. Subcommittee on Antitrust, Commercial and Administrative Law of the Committee of the Judiciary, US House of Representatives, above n 3, 269.
23. Khan, above n 4, 766.
24. Ibid 723.
25. Ibid 724.
26. Ibid 727.
27. Bush, above n 13, 511.

IMPORTANT NOTICE: This document is published by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL No. 421445 (Lonsec). Please read the following before making any investment decision about any financial product mentioned in this document.
Disclosure as at the date of publication: Lonsec receives fees from fund managers or product issuers for researching their financial product(s) using comprehensive and objective criteria. Lonsec receives subscriptions for providing research content to subscribers including fund managers and product issuers. Lonsec receives fees for providing investment consulting advice to clients, which includes model portfolios, approved product lists and other advice. Lonsec’s fees are not linked to the product rating outcome or the inclusion of products in model portfolios, or in approved product lists. Lonsec and its representatives, Authorised Representatives and their respective associates may have positions in the financial product(s) mentioned in this document, which may change during the life of this document, but Lonsec considers such holdings not to be sufficiently material to compromise any recommendation or advice.
Warnings: Past performance is not a reliable indicator of future performance. The information contained in this document is obtained from various sources deemed to be reliable. It is not guaranteed as accurate or complete and should not be relied upon as such. Opinions expressed are subject to change. This document is but one tool to help make investment decisions. The changing character of markets requires constant analysis and may result in changes. Any express or implied rating or advice presented in this document is limited to “General Advice” (as defined in the Corporations Act 2001 (Cth)) and based solely on consideration of the investment merits of the financial product(s) alone, without taking into account the investment objectives, financial situation and particular needs (‘financial circumstances’) of any particular person. It does not constitute a recommendation to purchase, redeem or sell the relevant financial product(s).
Before making an investment decision based on the rating(s) or advice, the reader must consider whether it is personally appropriate in light of his or her financial circumstances, or should seek independent financial advice on its appropriateness. If our advice relates to the acquisition or possible acquisition of particular financial product(s), the reader should obtain and consider the Investment Statement or Product Disclosure Statement for each financial product before making any decision about whether to acquire a financial product. Where Lonsec’s research process relies upon the participation of the fund manager(s) or product issuer(s) and they are no longer an active participant in Lonsec’s research process, Lonsec reserves the right to withdraw the document at any time and discontinue future coverage of the financial product(s).
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