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How Proposed Legislation Would Break Digital Services: the Prime Example

· November 1, 2021

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Controversial legislation in Congress is being described as spelling the end for Amazon Prime.  Why is that and what would it mean?

As digital services continue to be a legislative target, some bills being considered in Congress stand to cause permanent harm to widely used services. Two weeks ago, Senators Klobuchar, Grassley, and other cosponsors introduced S. 2992, the “American Innovation and Choice Online Act” (AICOA). This bill is the companion to Rep. Cicilline’s similarly named House bill, H.R. 3816, the “American Choice and Innovation Online Act,” (ACIOA), introduced earlier this summer. 

While the Senate version contains minor variations, both bills would have similar deleterious effects on the U.S. economy and consumers in general. Both target leading tech companies with onerous regulations, and would have serious consequences for consumers.  One consequence would be the dissolution of Amazon Prime as it is currently known. This post examines why that would be the case.

AICOA and ACIOA would target three key activities that enable Amazon Prime to be such an attractive and useful service for consumers: (1) self preferencing; (2) conditioning preferential status on the purchase of another service; and (3) curating recommendations for Amazon customers. According to the Senate proposal, each violation would result in a fine up to 15% of total revenue during the pendency of the violation (more than double Amazon’s net profit margin) and companies would be precluded from raising traditional pro-competitive or pro-consumer affirmative defenses. What this means in the case of Prime is that despite a wealth of evidence that consumers get great value out of free two-day shipping bundled with other services, none of that evidence is relevant to whether regulators impose penalties.

1. Ending Self Preferencing: The Impact on Prime

Both House and Senate versions of the bill create a blanket rule of “no self preferencing.” Anyone who has shopped in a grocery store will understand what self-preferencing is: ‘house’ or store brands are often visibly situated on end caps, or at eye-level, next to popular premium brands. By making the store brand visible, the store hopes to compete with name brands and introduce consumers to a more affordable option. But this would be prohibited online. 

Section 2(a)(1) makes it unlawful for a company to engage in conduct that would “unfairly preference the covered platforms operator’s own products, services, or lines of businesses over those of another business user on the covered platform in a manner that would materially harm competition on the covered platform”. This section would affect Prime in two ways. Compliance with section 2(a)(1) would either nullify Fulfilled By Amazon (FBA) — an option where sellers can pay Amazon to manage shipping a product from the seller’s warehouse to the Amazon customer through Amazon’s fulfillment chain in two or fewer days — or require Amazon to provide all sellers FBA at cost. That is because Amazon ships its own products using FBA at cost, and it would be “discriminatory” under the bill to sell FBA to third parties at anything other than cost. 

Amazon could not profit from this costly but innovative supply chain service offering, and in order to comply with the proposed legislation, it would be required to expand and maintain operations to provide for all potential third-party sellers to participate in the fulfillment services. The legislation’s cost-prohibitive mandates, combined with an obligation to bear risk without a corresponding opportunity for return, would thus result in the elimination of this service valued by both consumers and sellers.

Second, it is also worth noting that a blanket ban on self preferencing would also require that Amazon remove the Prime badges from Prime-eligible offers (because this could be interpreted as favoring Prime offers over non-Prime offers). By reducing customers’ ability to easily locate offers that carry the Prime promise of rapid delivery and premier customer service on returns and product handling, the value of the service would be considerably reduced. 

2. Conditioning Preferred Placement (Prime) on Purchase of Another Service 

The next activity both bills target is Amazon’s use of its fulfillment services to meet the Prime guaranteed two or one day shipping promise. Amazon’s Prime service allows members to shop an extensive range of both Amazon product offerings and eligible third-party offerings and receive them within one to two days. Amazon is able to deliver on this promise by having Prime-eligible products shipped using FBA. Amazon opened this up to third-party sellers, like small businesses, allowing them to make Prime-eligible offers that can meet customers’ delivery expectations.

Section 2(b)(2) of AICOA would make it unlawful for a covered platform to engage in conduct that would “condition access to the covered platform or preferred status or placement on the covered platform on the purchase or use of other products or services offered by the covered platform operator that are not part of or intrinsic to the covered platform itself”. Yet this is why Prime works: offers are Prime-eligible precisely because they can be delivered quickly via FBA.

There are two potential alternatives that Amazon can consider to comply with the statute, both of which will significantly diminish the Prime program. One alternative that would ensure compliance is for Amazon to cease offering Prime eligibility to third party sellers. Not only would this have a negative effect on sellers that appreciate access to a strong, low cost logistics supply chain, but it would also significantly diminish the breadth of what Prime customers would have access to under the Prime program. The second alternative is to allow third-party sellers to be eligible for Prime if they use alternative shipping services. Unfortunately, Amazon had previously tested this mechanism, and Prime fulfilled through FedEx and UPS without the use of FBA failed to consistently meet the two-day delivery promise for customers. In either case, much of the consumer incentive for Prime would be stripped away.  

3. Preventing Features of Tailored Recommendations

The third activity the bills targets is the ability for Amazon to tailor recommendations for customers based on product delivery speed and service features. Section 2(b)(6) of AICOA precludes self-preferencing in ranking functions. In addition, Section 2(b)(6) would prohibit using ranking to favor one business user over another. If multiple sellers offer the same product, one of the criteria Amazon considers when making a recommendation is Prime eligibility, so Prime subscribers know where they can take advantage of the service.  Section 2(b)(6) would prevent Amazon from highlighting a Prime offer over a non-Prime offer or even considering it as a relevant criteria, thereby preventing Prime subscribers from making the most informed choices.

Today, Amazon’s shopping results also highlight products and offers that have high quality ratings, are low cost, readily available and have expedient delivery and return services. The statute would require Amazon to exclude a key factor in shopping results–expedient delivery and return services enabled by Prime–and would require customers to individually hunt through all the listed product offerings to find results for guaranteed, two-day shipping.

And For Good Measure…

Compounding matters, AICOA does not require proof of actual harm. Under current law, complaints of anticompetitive conduct need to be supported by some evidence of an injury.  Here, legislators propose to require only a “de minimis” showing by a preponderance standard that the conduct would materially harm competition. With such a speculative standard, even a trivial violation could result in billions in penalties. This standard promises legal uncertainty and increased litigation. As a single violation could erase several years of returns, targeted firms like Amazon are likely to face investor pressure to mitigate risks, ultimately resulting in restructuring or completely eliminating at-risk products and features, including Prime.

Notably, these onerous regulations exclude brick and mortar retailers and foriegn technology rivals from any similar burden, as they are by design targeted against American firms with a large number of U.S.-based users. 

Conclusion

As outlined above, the Senate version of the House bill, AICOA, would likely prevent Amazon from offering its highly valued two-day shipping service. The only scenario where Amazon would not likely be required to end its two-day shipping is if Amazon chose to remove Prime eligibility for all third party sellers on its marketplace and sold only Amazon products through FBA. Even this outcome, however, would break Amazon Prime as we know it.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.