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Last week, the Washington, D.C. Attorney General Karl Racine filed an antitrust suit against Amazon. The point of the suit is simple, but not stated explicitly - to unravel Amazon Prime, which at this point has at least 126 million members, roughly the same number of households in America (128.5 million).

I’ve read a bunch of the coverage, but no one has hit that point yet. So that’s what I’m going to write about today.

Photo by Marco Verch, licensed via Creative Commons.

“Happily and Deeply Intertwined”

It’s a fascinating moment in the political fight over big tech. On the one hand, the four dominant tech firms have never been more powerful or profitable. On the other hand, there is increasingly a consensus that our political leaders have to do *something* about their power. As a result, Google and Facebook are facing government litigation, and Apple has been fighting off legislative attempts to rein in app stores. Nothing has yet breached the castle walls of any of these firms, but we’re getting closer all the time.

This week, it was Amazon’s turn. On Wednesday, Washington, D.C. Attorney General Karl Racine alleged that Amazon was using its power to manipulate online retail prices. But there is something a bit different about this case than the ones targeting Google and Facebook. As Shira Ovide put it in the New York Times, Racine is making the claim that Amazon isn’t just crushing competitors, but *raising* consumer prices in the process.

It’s a longstanding claim by some of the independent merchants who sell on Amazon’s digital mall that the company punishes them if they list their products for less on their own websites or other shopping sites like Walmart.com. Those sellers are effectively saying that Amazon dictates what happens on shopping sites all over the internet, and in doing so makes products more expensive for all of us.

The reason this case is considered important is because higher consumer prices fit within the orbit of the consensus for antitrust. While there are possible problems with the case, Racine isn’t going outside the orthodoxy of modern antitrust the way enforcers are with the Facebook case. Against Facebook, enforcers are trying to claim that Facebook is engaged in more surveillance than consumers would otherwise prefer, and that this choice is akin to a price hike. That’s true, but it’s a somewhat novel antitrust claim. In this case, Racine is saying Amazon raised consumer prices using monopoly power. This case is not pushing the boundaries of antitrust law, it’s straightforward consumer harm.

That said, I think there’s another important aspect of this case that has gone largely unmentioned, which is that the Amazon Prime program, the keystone that holds Amazon’s dominance over retail together, is effectively being subsidized by the scheme Racine laid out. If you get rid of Amazon’s ability to force sellers to keep their prices high, then Prime, and its promise of free shipping, falls apart, as does much of the Amazon Marketplace business model. Other parts of Prime, such as Amazon’s ventures in Hollywood (like its recently announced purchase of MGM), may also not make sense if Racine wins.

To understand why, we have to start with the idea of free shipping. Free shipping is the God of online retail, so powerful that France actually banned the practice to protect its retail outlets. Free shipping is also the backbone of Prime. Amazon founder Jeff Bezos knew that the number one pain point for online buyers is shipping - one third of shoppers abandon their carts when they see shipping charges. Bezos helped invent Prime for this reason, saying the point of Prime was to use free shipping “to draw a moat around our best customers.” The goal was to get people used to buying from Amazon, knowing they wouldn’t have to worry about shipping charges. Once Amazon had control of a large chunk of online retail customers, it could then begin dictating terms of sellers who needed to reach them.

This became clear as you read Racine’s complaint. One of the most important sentences in the AG’s argument is a quote from Bezos in 2015 where he alludes to this point. In discussing the firm’s logistics service that is the bedrock of its free shipping promise, Fulfillment by Amazon (FBA), he said, “FBA is so important because it is glue that inextricably links Marketplace and Prime. Thanks to FBA, Marketplace and Prime are no longer two things. Their economics . . . are now happily and deeply intertwined.” Amazon wants people to see Prime, FBA, and Marketplace as one integrated mega-product, what Bezos likes to call 'a flywheel,’ to disguise the actual monopolization at work. (Indeed, any time you hear the word ‘flywheel’ relating to Amazon, replace it with ‘monopoly’ and the sentence will make sense.)

Why would FBA be the glue here between Prime and Marketplace? Shipping and logistics is extremely expensive, far more than the membership fees charged by Prime; Amazon spent $37.9 billion on shipping costs in 2019, and much more in 2020. No matter how amazing your logistics operation, you can’t just offer free shipping to customers without having someone pay for it. Amazon found its solution in the relationship between Prime and Marketplace. It forced third party sellers to de facto pay for its shipping costs, by charging them commissions that reach as high as 45%, according to Racine, merely to access Amazon customers. That’s nearly half the revenue of a seller going to Amazon! And this high fee isn’t just because fulfillment or selling online is expensive; Walmart charges significantly less for its fulfillment services and access charges to its online market, and eBay’s market access fees are also much lower than Amazon’s.

(A brief word on numbers. The Institute for Local Self-Reliance found a slightly different number for Amazon’s seller charges, 30% for FBA plus 5-10% for seller fees, while agreeing with Racine on significant price hikes from 2014-2020, what is known as ‘recoupment’ in predatory pricing cases. Another firm calculated the amount paid to Amazon at 27% for an average seller in 2019, and found that number had jumped 42% over five years. One reason we don’t know the actual number Amazon charges third party sellers is because Amazon is hiding this data from investors and fighting the SEC to do so.)

How does Amazon force sellers to pay such high fees? Monopolization! The scheme itself is subtle, and requires a bit of explanation. Nearly anyone may list their wares on Amazon, but the ability to actually get your wares in front of customers is dependent on being able to ‘win the Buy Box,’ which is that white box on the right-side that you get to after you search for an item on Amazon. Over 80% of Amazon purchases go through the Buy Box. The Buy Box is the lever Amazon uses to control access to customers.

Amazon awards the Buy Box to merchants based on a number of factors. One factor is whether a product is ‘Prime eligible,’ which is to say offered to Prime members with free shipping. In order to become Prime eligible, a seller often must use Amazon’s warehousing and logistics service, Fulfillment by Amazon (FBA). In other words, Amazon ties the ability to access Prime customers to whether a seller pays Amazon for managing its inventory. This strategy has worked - Amazon now fulfills roughly two thirds of the products bought on its platform.

The high prices of overall marketplace access fees, including FBA, is how Amazon generates cash from its Marketplace and retail operations. From 2014 to 2020, the amount it charges third party sellers grew from $11.75 billion to more than $80 billion. “Seller fees now account for 21% of Amazon’s total corporate revenue,” noted Racine, also pointing out that its profit margins for Marketplace sales by third party sellers are four times higher than its own retail sales.

In addition, sellers are prohibited from charging for shipping from Prime members, though they are allowed to charge shipping from non-Prime members.

How do sellers handle these large fees from Amazon, and the inability to charge for shipping? Simple. They raise their prices on consumers. The resulting higher prices to consumers, paid to Amazon in fees by third party merchants, is why Amazon is able to offer ‘free shipping’ to Prime members. Prime, in other words, is basically a money laundering scheme. Amazon forces brands/sellers to bake the cost of Prime into their consumer price so it appears like Amazon offers free shipping when in reality the cost is incorporated into the consumer price.

Now, if this were all that was happening, sellers and brands could just sell outside of Amazon, avoid the 35-45% commission, and charge a lower price to entice customers. “Buy Cheaper at Walmart.com!” should be in ads all over the web. But it’s not. And that’s where the main claim from Racine comes in. Amazon uses its Buy Box algorithm to make sure that sellers can’t sell through a different store or even through their own site with a lower price and access Amazon customers, even if they would be able to sell it more cheaply. If they do, they get cut off from the Buy Box, and thus, cut off de facto from being able to sell on Amazon.

Amazon has between a half and three quarters of all customers online, so not being able to sell on Amazon is a nonstarter for brands and merchants. As a result, to keep selling on Amazon, merchants are forced to inflate their prices everywhere, with the 35-45% commission baked into the consumer price regardless of whether they are selling through Amazon. When you buy on Walmart, or at some other retail outlet, or even direct from the brand, even if you aren’t paying Amazon directly, the price reflects the high cost of selling on Amazon. As a result, sellers and brands tend to raise their prices across the board so that Amazon users can’t find better deals anywhere else. Prime thus looks like a good deal, but only because sellers are prohibited from offering customers a better one anywhere else.

If Racine succeeds in his suit, it unravels the whole scheme. As one legal analyst told me, “Let's say a product today is sold for $10 on Amazon with 'free shipping'. If Amazon is forced to unbundle the FBA fee from the product price then it would cost $6 + $4 shipping. Prime makes no sense in this world unless Amazon again decided to subsidize Prime.” Amazon, as big as it is, doesn’t have $25-30 billion of cash flow to make that happen.

To most consumers, Prime looks like a lovely convenience offering free shipping, and it’s hard to find better prices elsewhere. But the reason you can’t find better prices isn’t because Amazon sells stuff cheap, but because it forces everyone else to sell stuff at higher prices. All of this is done so Amazon can continue to offer ‘free shipping’ while using access to its hundred million plus Prime members as a cudgel to force third party sellers to pay high fees.

Amazon also uses its bazooka of cash from Prime members paying high consumer prices, laundered through third party sellers, to distort industries across the economy. Amazon spent some of it to build out a Hollywood studio, offering its original content ‘free’ to Prime members, who are of course indirectly paying for it with higher consumer prices. Prime also offers free video games and millions of songs. But none of this is actually free, it’s paid for by Prime members in ways that Amazon disguises with its coercive arrangements.

What Racine’s case shows is that Prime is just a huge public relations stunt, a giant lie by Amazon to mask the high prices it forces across the economy. If people figure this out, it’s a devastating blow to Amazon’s credibility. And it looks like Karl Racine, plus the other enforcers who are investigating but haven’t brought a suit, know the score.

Biden vs The Deep State: Hearing Aid Edition: One of the scams in American medicine is hearing aids, which can cost up to $5-10k apiece. That is an insane price, for what is essentially an adjustable microphone. There are roughly 40 million Americans with some form of hearing loss, which can lead to dementia, and many of them can’t afford hearing aids because of the ridiculously high price.

There is no reason for these prices except monopoly power. In this case, the monopoly is government-created through a requirement that hearing aids be accompanied by a prescription offered by an audiologist. Audiologists are necessary specialists in many cases of hearing loss, but not all. The requirement that every hearing aid must be a prescription hearing aid redounded to the benefit of audiologists, as well a small cartel of firms who made approved hearing aid devices that cost huge sums of money. (It’s a similar dynamic in glasses and contact lenses, which is why they are so much cheaper in Asia.)

Back in 2017, Elizabeth Warren and a group of Republican Senators passed a bill forcing the Food and Drug Administration to break this monopoly. The bill mandated the FDA allow over the counter hearing aids, which is to say, hearing aids that do not require a prescription and can be adjusted by the individual user. With smartphone technology, over the counter hearing aids have become far more practical, and so such a regulatory change was long overdue. The day the bill passed, shares of the firms that control the hearing aid market took a 10-20% dive, anticipating lots of competition. And sure enough, Bose announced a cheaper hearing aid in 2018.

But the FDA has been dragging its feet, missing the 2020 deadline in the bill to issue guidance for an over the counter hearing aid market. Bose, with special dispensation from the FDA, finally launched its $850 device, but is not allowed to market it as a hearing aid because regulators haven’t created the category yet.

It’s a frustrating situation. There will be lots of competition in this market, and prices will plummet. Indeed, they are plummeting already, but we should be further along by now.

Plymouth Rock's Grist Mill: America's First Businesses Were Public Utilities: Last week, on vacation, I went to one of America’s first independent businesses, a grist mill constructed to serve the Pilgrims at Plymouth Rock who grew corn and needed it ground efficiently. It turns out, the colonial government granted a charter, set prices, had consumer protection laws, and forced price transparency. It even threatened to create competition when the miller’s quality began declining precipitously. If you want to read snippets of old colonial laws around public utility regulation, here you go. But just know that America was never a land of laissez-faire, not even when Pilgrims first landed.

Thanks for reading. Send me tips on weird monopolies, stories I’ve missed, or comments by clicking on the title of this newsletter. And if you liked this issue of BIG, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you really liked it, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.

cheers,

Matt Stoller

P.S. I’ve heard a fairly credible rumor that Viacom and Comcast/NBC are in merger talks. The logic behind this merger attempt would make a lot of sense, but I don’t know if it’s true. I am trying to run this down, so if you have any information either confirming or denying this rumor, let me know.

Amazon Prime Is an Economy-Distorting Lie

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