Should e-commerce giants like Amazon and eBay be held to account for illegal knock-offs sold by third parties on their platforms? Studying the incentives and tradeoffs faced by platforms and policymakers in the fast-changing digital economy is a core ambition for the TSE Competition Policy & Regulation Center. In a new working paper, Doh-Shin Jeon, Yassine Lefouili and Leonardo Madio investigate the impact on innovation and consumers of forcing platforms to ban third-party sellers who break intellectual property (IP) laws.
How serious is the problem of counterfeit sales online?
DSJ: Counterfeits account for 3% of global trade and there is growing concern about their diffusion on online markets. With their immense customer reach, e-commerce platforms have been described by the OECD as “an ideal storefront” for fake goods and services. Unscrupulous sellers based in other countries can be hard to identify or bring to the courts. Meanwhile, the incentives for platforms to police their own marketplaces may be limited by the commissions the platform gains from transactions, especially when counterfeits do not directly harm consumers.
Such concerns have led to growing demands that platforms should take more responsibility. Major brands have filed lawsuits against platforms in recent years. Both Nike and Birkenstock decided to pull their products from Amazon, claiming that the platform was not doing enough to prevent misconduct by third parties. Louboutin has also recently complained about IP-infringing products on Amazon but, interestingly, the courts found Amazon was not liable.
How does your paper address this issue?
YL: Platforms face an important tradeoff when deciding whether to allow copycats and counterfeiters to operate on their marketplaces. A permissive approach might lower incentives for innovators to develop new products; at the same time, it may also increase the platform’s market reach and sales. We focus on a specific type of platform – e-commerce firms and app stores – and examine whether they should be liable for IP infringements by third parties. In particular, we study the impact of the introduction of liability on innovators’ incentive to innovate and consumer welfare.
In our model, to benefit from liability exemption, platforms have to comply with a minimum screening requirement and the obligation to delist any IP-infringing product. Importantly, we only consider infringements by non-deceptive third parties. In other words, the copycat products are not harmful in the sense that consumers know they are buying a low-quality version of the original. After all, in most countries and on most platforms, you can return a product if it doesn’t match what you thought you were buying.
Do your results suggest that platform liability is a good idea?
LM: Our first result, which we call the IP-protection effect, finds that more screening by the platform induces more innovation. But we also identify various unintended consequences on innovation and consumers, which can be both positive and negative, stemming from the impact of liability on buyer participation and the commission rate.
Buyer participation can decrease, which may lead to less innovation and a lower consumer surplus. At the same time, there can be positive unintended effects when the platform reacts to increased liability by lowering the commission rate. A lower commission, leading to more innovation and consumer benefits, can arise when the platform earns more by increasing the number of product categories available. Alternatively, liability can increase the commission rate, reducing innovation, when the platform earns more by extracting a higher surplus per product category.
DSJ: Cross-group network effects, which arise when the number of users on one side of the platform depends on the number of users on the other side, crucially affect the desirability of platform liability. The reason is that they affect the “elasticity” of the number of users on each side of the platform, that is, how sensitive the number of users is to changes in key determinants of their decision to join the platform. For instance, platform liability is likely to increase both innovation and consumer surplus when the elasticity of the number of innovators is high and that of buyers is low. By contrast, when the elasticity of the number of innovators is low and that of buyers is high, platform liability is likely to reduce consumer surplus and innovation.
What advice would you offer policymakers?
YL: Under existing regimes, digital platforms generally benefit from liability exemption. However, policymakers are starting to pay more attention to this topic, with Europe’s Digital Services Act placing additional obligations on very large platforms. Elsewhere, new proactive regulation includes the UK Online Safety Bill, the INFORM Consumers Act in the US, and the new Electronic Commerce law in China. Our paper shows that policymakers would do well to consider the unintended effects of introducing platform liability, as these can substantially affect its desirability.
To begin with, even when the policy fulfills the goal of protecting IP rights and stimulating innovation, there might be a negative effect on consumers. Second, the introduction of platform liability does not necessarily lead to an increase in the platform’s commission. It may induce a decrease in that commission and, thereby, reinforce innovation incentives. Third, policymakers should foresee strategic reactions not only by the platform but also by imitators who might respond to platform liability by becoming legitimate, potentially reducing innovation by brand owners. Finally, policymakers should account for the elasticity of the number of users on each side of the platform when deciding whether to hold it liable for IP infringements by its users. Our analysis suggests that a higher elasticity of the number of innovators tends to make platform liability more likely to be desirable while a higher elasticity of the number of buyers has the opposite effect.
The researchers’ working paper ‘Platform Liability and Innovation’ is available to read at www.tse-fr.eu
Article published in TSE Reflect, September 2022