Exclusivity is the Mother of Invention

The web is all aflutter in the debate over handset exclusivity. Harold Feld of Public Knowledge describes in a recently posted video how exclusive deals prevent competition between handsets and raise prices. Wayne Crews and Ryan Young of CEI have fired back, pointing to a handset market with literally dozens of competing devices.

The notion that exclusivity necessarily precludes competition is simply absurd. Apple’s deal with AT&T is precisely the opposite of monopoly. Far from cornering the market on smartphones, Apple has openly refused to sell the iPhone to most of its potential customers. If anything, nonexclusive sales would have discouraged competing handsets, undercutting the incentive for Verizon and Sprint to pay for their exclusive rights to the Blackberry Storm and the Palm Pre. Mr. Feld bemoans that these top-tier phones aren’t competing within any single provider, but this is just like stating that Coke and Pepsi don’t compete because they are sold in separate vending machines.

On the second point, though–that exclusive deals raise prices–Mr. Feld and other pro-regulation advocates have a point. AT&T pays Apple a hefty sum not to make the iPhone available to customers of other providers. That means the phones cost AT&T more than they would’ve otherwise, and customers in turn pay more for them. High prices are a signal to new entrants, of course, but Mr. Feld would certainly push the point. Could Congress really lower prices for consumers, without price controls or their attendant shortages, in one stroke of the regulatory pen?

Well, yes and no. It is likely that the price of the iPhone would fall if government forced Apple to abandon its agreement with AT&T. Prices would fall further still if regulators subpoenaed Apple’s schematics and source code and revoked its patent claims. But while critics attack exclusivity in the margins of Apple’s profits, no one questions the the very core of those profits: the intellectual property and corporate secrets that make the the iPhone so valuable. Why such different reactions to essentially the same business practice? Because novelty is scary. Apple’s sole production rights to the iPhone are nothing special, but its deal with AT&T is somewhat new.

We’re not used to seeing exclusive monopolies in established products, and for good reason. A monopoly is extremely difficult to maintain, and usually only possible with the help of government. It would certainly be unusual if steel, bananas, or personal computers were controlled by a single manufacturer, and it was terrible for consumers when Ma Bell—with great help from the FCC—owned the entire American telephone industry. On the other hand, there’s nothing unusual at all about Scholastic’s sole publishing rights to Harry Potter, or Amazon’s exclusive ownership of the Kindle. Why are we so accustomed to monopolies in some sectors, but wary of them in others?

The answer is that exclusivity can be perfectly natural, and sometimes even essential, for new and innovative products. Every invention starts out exclusive to its creator. Only by leveraging that exclusivity can the creator make a profit. Once a product is well-established, only an act of government can restrict its supply. It took several acts for the FCC to entrench the Bell monopoly, and it would take another to stop Apple’s competitors from building a better smartphone. Good things come to those who wait.

Ultimately, what Mr. Feld is advocating is a textbook case of the broken window fallacy. Whenever a new product is invented, society can always gain by revoking the creators exclusive rights, if we look only at that product in isolation. But it’s like cheating at poker: eventually your friends learn not to play. Prohibitions on exclusivity create shortages just like any other price control, even if these innovation shortages don’t make the evening news. Prominent benefits and hidden losses are a magnet for bad policy, and they can fool even economically literate folks like Mr. Feld who should know better.